ETFWhat are ETFs and how do they work?


  • An Exchange Traded Funds (ETF) is a basket of shares that replicates performance and therefore the performance of a broad or specific market segment (benchmark index). An ETF is a type of fund that holds a number of underlying securities (stocks, bonds, oil futures, gold, foreign currency, etc.)

    They are listed and traded on official stock exchanges and can therefore be purchased and sold normally as with any shares.

     

    • Difference between common fund and ETF

    ETFs are very similar to mutual funds, but they are listed on a stock exchange and prices constantly change during the day.

    They also have higher liquidity and lower costs than common funds. Since it is listed as a regular stock, it does not have the "net asset value" posted at the end of the day, like the funds.

    Unlike common funds, you can set stop loss and limits or even buy them in margin and sellshort.

     

    • Benefits of ETFs

    The great benefits of ETFs are many and considerable:

    - Diversification: With an ETF there is only one investment already diversified within it, as it represents a basket of shares, and consequently with low risks.

    - Reduced management costs: the investor does not have to pay any "entry", "exit" or "performance" fees (except those charged by his/her intermediary). Each ETF has a TER, i.e. Annual Total Commissions, which may vary but generally not exceed 0.90% per annum and is paid in proportion to the ETF holding period.

    - Great liquidity: that is, easy buying, because they are traded within the world's major stock markets throughout the day, just as it happens with the shares

    - Versatility: thanks to the ETFs even the small savers can invest on the major market indexes without having to replicate the index by buying all the stocks in their basket

    - Efficiency: Passive management (hence the fact that the ETF does not try to beat the market like making funds but simply replicating a given index) makes the ETF cheaper but at the same time able to monitor good returns.

    - Transparency: the high degree of transparency of the investment is inherent in the very nature of the ETF, thus the replication of the benchmark index chosen and the consequent possibility of knowing in real time the exposure and being able to monitor the trend.

    - Absence of insolvency risks: the assets invested in the ETFs are also returned in the event of bankruptcy of the companies involved in the business, as they are assets separate from the corporate assets

     

    • Tip

    We recommend that, in order to have the flexibility of a low-cost ETF trading performance similar to an index fund, it is best to use only the largest and widely traded ETFs, those designed to fit well-known benchmarks and trace Documents that show their accuracy.

Interviews

  • the Analyst's answer

    Jean Grossett - Financial analyst

    An exchange traded fund (ETF) can be likened to tradinga company’s stock.ETFs track a collection of assets similar to an index fund, experiencing daily change in price as they are bought and sold, with lower operational cost and higher daily liquidity unlike mutual fund.

    ETFs are an attractive trading vehicle for most solo investors, since most of them are more familiar with how the stock exchanges work, trading during the day, unlike a mutual funds which trade only at end of day at the net asset value (NAV) price. Using ETFs as an investment vehicle does not allow for trigger of taxable events, since the transactions created are not considered as sales.

    Given that ETF shared are traded on public stock exchanges, shareholders of this investment (ETF) can easily transfer ownership, or sell them similar to stock shares.

    ETF shares are supplied through a system of creation and redemption. This process involves large financial e.g. market maker. They are called authorized participants (APs), reason being that they have huge buying power. During creation, an AP assembles the required portfolio of underlying assets and turns that basket over to the fund in exchange for newly created ETF shares. Similarly, for redemptions, APs return ETF shares to the fund and receive the basket consisting of the underlying portfolio. Each day, the fund’s underlying holdings are disclosed to the public.

    “The creation process of an ETF. Redemptions operate in reverse, with authorized participants presenting ETF shares to the fund or trust in exchange for a basket of securities.”Image courtesy

  • the Manager's answer

    Robert Danvil - Investment Manager

    There are 2 ways traders participate in ETFs which are mainly Leveraged ETFs and Arbitrage.

    The ETF and the underlying basket of assets present traders with arbitrage opportunities allowing a trader buy ETF shares and sell the underlying portfolio since both are traded throughout the day, hence making some profit off the difference. Using derivative products, leveraged or Inversed ETFs can be created, therefore tracking opposite returns of the underlying assets. For example, a 2x gold ETF would gain 2% for every 1% gain in metal price.

    An investor owning ETFs have the advantages of benefiting from both worlds, in terms of an index fund’s diversification as well as buy on margin or short selling. With ETFs , there are usually no minimum deposit requirements, it is possible to buy as little as a single share with a better taxation compared to mutual funds.

    Examples of popular and widely traded ETFs are Dow Jones Industrial Average (DIA), Nasdaq 100 tracked by the QQQ, and the S&P 500 Index called the (SPDR), which trades under the ticker SPY. There are other ETFs like Commodity ETFs and Sector ETFs tracking different industries, such as financial, energy, oil companies etc.

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