Exchange Traded Funds Definition & Explained with Examples. Essentials of Investments

Описание: IN this video, I expanded on the definition of the exchange traded funds. An exchange-traded fund (ETF) is a type of investment fund and exchange-traded product, i.e. they are traded on stock exchanges.

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Exchange-traded funds (ETFs) are offshoots of mutual funds first introduced in 1993 that allow investors to trade index portfolios just as they do shares of stock. The first ETF was the “Spider,” a nickname for SPDR or Standard & Poor’s Depository Receipt; the ETF maintains a portfolio matching the S&P 500 Index. Unlike mutual funds, which can be bought or redeemed only at the end of the day when NAV is calculated, investors could trade Spiders throughout the day, just like any other share of stock. Spiders gave rise to many similar products such as “Diamonds” (based on the Dow Jones Industrial Average, ticker DIA), Qubes (pronounced “cubes,” based on the NASDAQ 100 Index, ticker QQQ), and WEBS (World Equity Benchmark Shares, which are shares in portfolios of foreign stock market indexes). By early 2017, about $2.5 trillion was invested in about 1,700 ETFs in five general classes: broad U.S. market indexes, narrow industry or “sector” portfolios, international indexes, commodities, and bond portfolios.

The leader in the ETF market is BlackRock, which uses the product name iShares. The firm sponsors ETFs for several dozen equity index funds, including many broad U.S. equity indexes, broad international and single-country funds, and U.S. and global industry sector funds. BlackRock also offers several bond ETFs and a few commodity funds such as ones for gold and silver. For more information on these funds, go to www.iShares.com.

More recently, a variety of new ETF products have been devised. Among these are leveraged ETFs, with daily returns that are a targeted multiple of the returns on an index, and inverse ETFs, which move in the opposite direction to an index. A more recent innovation is actively managed ETFs that, like actively managed mutual funds, attempt to outperform passive indexes. However, until recently, these funds have had to report portfolio holdings on a daily basis, which makes it easy for competitors to take advantage of their buying and selling programs. This requirement has severely limited the growth of this segment of the market. In 2014, however, the SEC gave permission to Eaton Vance to offer an actively managed “non-transparent” ETF that is required to report its portfolio composition only once each quarter, the same frequency at which mutual funds disclose their portfolio holdings. Other companies such as BlackRock have also indicated interest in sponsoring nontrans parent ETFs. At the end of 2016, there were 148 actively managed ETFs registered with the SEC with combined assets of nearly $29 billion.

Other even more exotic variations are so-called synthetic ETFs such as exchange-traded notes (ETNs) or exchange-traded vehicles (ETVs). These are nominally debt securities but with payoffs linked to the performance of an index. Often that index measures the performance of an illiquid and thinly traded asset class, so the ETF gives the investor the opportunity to add that asset class to his or her portfolio. However, rather than invest in those assets directly, the ETF achieves this exposure by entering a “total return swap” with an investment bank in which the bank agrees to pay the ETF the return on the index in exchange for a relatively fixed fee. These have become controversial, as the ETF is then exposed to risk that in a period of financial stress, the investment bank will be unable to fulfill its obligation, leaving investors without the returns they were promised.

ETFs offer several advantages over conventional mutual funds. First, as we just noted, a mutual fund’s net asset value is quoted—and therefore, investors can buy or sell their shares in the fund—only once a day. In contrast, ETFs trade continuously. Moreover, like other shares, but unlike mutual funds, ETFs can be sold short or purchased on margin.