Exchange Traded Funds (ETFs)

What is an ETF?

Exchange Traded Funds Definition: Exchange Traded Funds, commonly known as ETFs, are the most marketable funds that are capable of tracking a commodity, an index, bonds and even index funds that happen to be a basket of the assets.

ETF funds are not similar to the mutual funds and trades more like some common stock that are present at stock exchange.

What does ETF mean in Stocks?

Throughout the day, there is continues buying and selling of the ETFs in the stock market which is why their price tends to change the entire day.

How is an ETF different from a Mutual Funds?

Comparing ETF's to the mutual funds, ETFs definitely have higher liquidity as well as lower fees, which make them the best alternative of the mutual funds. Although ETF trading is similar to stocks but they do not have their NAV (net asset value), calculated at the end of the day. ETFs are also known as Passive Index Funds.

Is ETF a widely spread industry?

Since 2015, the assets that are invested in the ETFs, for the first time, have exceeded the volume of assets invested in the Hedge Funds. This shows that how much ETF industry has grown as well as has transformed management industry of the global fund. By the end of 2016, over $3 trillion has been traded in ETFs

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Why ETF?

There are a lot of benefits that comes with choosing ETF, however one of the main benefit is that they are the key to well balanced portfolio, without costing a lot money. Furthermore, they also allow the investor to change his portfolio as a response to the changing circumstances. In simple words, ETF allows the investor to have diversified portfolio.

Are ETF flexible?

ETF are not similar to mutual funds that are typically priced after the market is closed. ETFs are priced throughout the day since their trade continues to roll the entire day. An ETF can be sold short, bought on the margin, or held for a long time. Since the value of ETF is based on underlying index, the ETF have additional advantages of offering huge diversification as compared to holding shares in any single company. This quality of ETF makes it highly flexible.

Can you compare ETFs?

There are a lot of important factors that one need to keep in mind when it comes to investing in the different ETFs. The most important factors are mentioned below:

  • Liquidity
  • Costs
  • Tracking Error
  • Replication Method

How expensive can be "Investing in ETF"?

The buying & selling cost of ETFs is something that the investors should know before investing in ETF. Their transaction cost is inclusive of brokerage fees, as the ETFs are basically traded on exchange. Moreover, when it comes to liquidity of the ETF, it has significant effect of amount of bid-ask spread, which means there will be another cost factor that the investor should consider. ETF issuers also charge a certain annual fees in the name of ETF management. This fee is not part of buying and selling cost. However, this management fees are comparatively lower than the other funds that are actively managing.

Furthermore, the ETF investor should also keep in mind that when it comes buying and selling of the ETF, private investors are imposed much higher transactional cost as compared to the professional fund managers.

How important are ETF sponsors?

There are a huge number of ETF sponsors these days, more likely over a dozen. At times, an exclusive license is given by index manager which is for some particular index. For that particular index there will be single sponsor who will be offering some product that matches that particular index. Moreover, for every sponsor there are different policies regarding fees, expenses structure, different marketing levels and willingness to maintain the funds open below some specific level of the assets.

Are REITs and ETFs similar?

A common misconception about ETF is that they are similar to REIT. Real Estate Investment Trust, also known as REIT, is basically an operating company that has office, employers and routine business operation to manage. The REITs are mandatory by law in order to focus on the buying, managing and developing real estate properties. They are as required by the law to pay a handsome percentage of the total earnings as the dividends. While on the other hand, ETF is not any company. Exchange Traded Funds (ETFs) are basically fund that are established by some fund sponsor and are designed to hold assets including bonds and stocks.

What "Tracking Error" stands for?

Tracking Error basically is a term that is used to describe difference between index return that are replicated by ETF and ETF yield. In technical terms, Tracking Error is described as standard deviation of difference between index yield and ETF yield. ETF however cannot 100% replicate index and there are different reasons behind it e.g. if an index has presence of illiquid securities, it can be extremely expensive to completely replicate it.

How can you determine liquidity of ETF?

If an ETF can be sold or bought at any time without a huge discount or market from market price, it has very high liquidity. ETFs liquidity is not dependent only on the volume of individual trading but also on the fact that how difficult is the buying as well as selling of the investments that are underlying traded index. The securities that low liquidity and lower trading volume are not necessarily part of the ETF, which results in tracking error.

Is ETF tax efficient?

When it comes to ETF and taxes, there is capital gain tax that is to be paid when profit is made from the sale of an ETF. However, these capital gain taxes that are imposed on asset in the ETF are only to be paid when entire ETF is sold and not when you are still holding ETF. The ETF assets are less actively traded in comparisons with the equities that are in mutual funds, however, there can be any stock in ETF that is to be changed to make adjustments. However, you do not have to pay tax on these gains until you decide to sell entire ETF. This quality of ETF makes it tax efficient.

What are big ETF issuers?

With the increasing popularity of the ETFs, the total number of the issuers has also grown to a huge number. Vanguard, Blackrock, SSgA, Charles Schwab and PowerShares, are among the 5 best performing etfs.

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What are Synthetic ETFs?

When any index fund that actually replicates any benchmark index that also without acquiring underlying, is known as synthetic ETF. Issuers basically use the synthetic ETFs in order to track some index that has little or almost zero tracking error. The issuer cannot acquire physically underlying assets since only selected amount of raw material can be actually replicated synthetically.

What is Physical ETF?

The physical ETF by purchasing the securities tracks any reference index. In order to carry out the complete replica, securities are to be purchases. If there is huge number of securities in the index, then the securities that hold sufficient liquidity will be acquired. The securities that are the representative of index are chosen and tracking error is also reduced simply by adding securities that have high correlation to performance of reference index

Is ETF beneficial against the actively managed funds?

ETF are usually classified as cost efficient, transparent as well medium-term investment as compared to actively managed funds. It is easy for the investors to keep track of a ETF's performance all the time. There is no need to hire a team of fund managers in order to manage ETF funds, which will lead the investor to low administrative cost.

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