Exchange-Traded Fund (ETF)

An Exchange-Traded Fund (ETF) is an investment fund containing a set of securities such as stocks that mostly follow an underlying index, though they may invest in any number of market sectors or use specific strategies. It is traded sort of stock throughout the trading day at fluctuating prices. Most ETFs track an index, like a stock market index or bond index. It’s could also be attractive as investments thanks to their low costs, tax efficiency, and stock-like features.

ETFs are in many ways similar to mutual funds; however, they are listed on exchanges, and ETF shares trade throughout the day just like an ordinary stock. Investors of these funds do not own the underlying assets directly, but instead, have an indirect claim and are entitled to a share of the income and residual interest in the event of liquidation of the funds. ETF dealers purchase or sell ETFs only directly from or to licensed participants. In the secondary market, their ownership interests or interest can be readily bought and sold.

ETFs are offered on virtually every conceivable asset class from traditional investments to so-called alternative assets like commodities or currencies. Additionally, creative ETF structures allow investors to gain access to short markets and escape taxes on short-term capital gains. ETFs can contain many sorts of investments, including stocks, commodities, bonds, or a combination of investment types. An exchange-traded fund may be marketable security, meaning it’s an associated price that enables it to be easily bought and sold.

A unique feature of an Exchange-Traded Fund is that its Authozied Participants (APs) who help facilitate the marketplace for fund units. The value of an ETF’s shares will change throughout the trading day because the shares are bought and sold on the market. APs are large financial institutions that have huge buying power and market makers, like large broker-dealers and investment banks and corporations.

An ETF is a type of fund that holds multiple underlying assets, rather than only one like a stock. Because there are multiple assets within an ETF, they can be a popular choice for diversification. APs select the appropriate portfolio of asset components when forming the fund, and turn the basket over to the fund in exchange for a number of newly created ETF shares. When redemption conditions arise, APs return the ETF shares to the fund and collect the basket of the portfolio. By using a retail broker who trades in the secondary market, individual investors can participate.

There are many types of Exchange-Traded Funds (ETF). Some of the most common ETFs include:

  • Bond ETFs – An exchange-traded fund (ETF) primarily invests in bonds or other assets with a fixed return. They can be based on a single category of bonds or provide a widely diversified portfolio of various types of bonds with varying maturities.
  • Stock ETFs – These hold a particular equity or bond portfolio, and are similar to an index. These can be viewed like normal stocks in that they can be sold and purchased for a fee and exchanged on an exchange all day long.
  • Commodity ETFs – It is designed to track the price of a commodity, such as gold, oil, or corn.
  • Style ETFs – This is designed to chart an emphasis on investment style or market capitalization, such as large-cap valuation or development in small-cap.
  • Index ETFs – Those emulate a common index, for example, the S&P 500 index. These can cover particular industries, different stock classes, or equities in international or emerging markets.
  • Foreign market ETFs – It is designed to track non-US markets, such as Japan’s Nikkei Index or Hong Kong’s Hang Seng index.
  • Inverse ETFs – It’s an attempt by shorting stocks to earn gains from stock declines. Shorting sells a stock, expects a fall in value, and repurchases it at a lower price.
  • Actively managed ETFs – It is designed to outperform any index, unlike most ETFs, which are designed to track an index.
  • Leveraged ETFs – Exchange-traded funds (ETF) consisting mainly of financial instruments providing the opportunity to hedge portfolios and thus potentially enhancing returns. These are typically used by traders who are looking to exploit short-term trading opportunities in major stock indexes by speculators.
  • Alternative investment ETFs – Innovative structures, such as ETFs, which allow investors to trade volatility or become exposed to a particular investment strategy, such as carrying currency or covered call writing.

Investors should bear in mind that several inverse ETFs are exchange-traded notes (ETNs) and not true ETFs. An ETN may be a bond but trades sort of a stock and is backed by an issuer sort of a bank. Take care to test with our broker to work out if an ETN may be a right appropriates our portfolio. Unlike a corporation stock, the quantity of shares outstanding of an ETF can change daily thanks to the continual creation of recent shares and therefore the redemption of existing shares. An ETF’s ability to issue and redeem shares on an ongoing basis keeps the ETF’s market value in line with its underlying securities.

 

Information Sources:

  1. fidelity.com
  2. corporatefinanceinstitute.com
  3. investopedia.com