How does an ETF investment work?
by: Daniel Webb
What is an exchange-traded fund (ETF)?
An ETF Investment is an exchange-traded fund, a type of investment vehicle traded on stock exchanges. ETF stocks are traded like single shares, with the prices changing all through the day.
An ETF characteristically holds assets such as stocks (usually an assortment of investments in unit trusts and investment trusts) or bonds. A lot of ETFs in fact track an overall index, such as the S&P 500 or MSCI EAFE. An ETF’s total value is typically just about the same price as the net value of the asset value of its underlying assets; if it is tracking a total index, its value naturally moves in line with changes in that index. Only “authorized participants” (typically large investors) are in fact allowed to transact directly with the ETF in terms of buying or selling shares from or to the fund manager. Such transactions usually involve the purchase or sale of “creation units” (i.e. groups of tens of thousands of ETF shares. Individual investors then go through these “authorised participants” to buy ETF stocks and to formulate their ETF trading strategies.
How long have ETFs been around?
ETF’s are a relatively fresh product, having been offered in the US only since 1993. In 1992, the American Stock Exchange (AMEX) made use of the SEC’s “SuperTrust Order” to request use of the first authorized ETF. The SEC approved that petition, and granted the SPDR Order in October, 1992, enabling the AMEX to subsequently list the S&P Depositary Receipts, Trust Series 1 (aka “Spider”) (which was benchmarked to the Standard & Poors’ 500 Index) the following year. ETFs was introduced into Europe a few years back, in 1999. (In the US, in addition to “Spiders”, new ETFs followed benchmarks like the Dow Jones Industrial Average (DIAMONDS Trust Series 1 (”Diamonds”), and the NASDAQ (NASDAQ 100 Index Tracking Stock (”Cubes”) followed in 1998 and 1999 respectively..)
As such, ETF’s have to date been mainly what might be called “index funds” which track entire indexes (as above). While, during their short history to date, ETFs have traditionally been the domain of large and/or offshore investors, with private investors reluctant to trade in them, this trend is changing. Now private investors account for approximately 40 percent of ETF trades in the US, a proportion that seems set to rise. One reason that private investors have become more interested in ETFs is that they provide access to funds that track assets and sectors that were previously only available to larger investors.
Types of ETF Investments available
Since their initial launch, a number of different types of ETF have developed in the market place. These include Open-end index funds (products include iShares, Select Sector SPDRs, PowerShares, Vanguard, and WisdomTree), Unit Investment Trusts (UITs) (products include BLDRs, Diamonds, SPDRs, and PowerShares QQQ Trust ), Grantor Trusts (products include Currency Shares, streetTRACKS Gold Shares, iShares Silver Trust, and Merrill Lynch HOLDRs), Exchange-traded Notes (ETNs) (products include iPath ETNs, ELEMENTS ETNs) and Partnerships (products include U.S. Oil). (Source: EFTGuide.com). In 2003 assets held by ETFs in the US alone surpassed US$155 Billion.
To understand whether ETF investment is suitable for you and in choosing which particular vehicle to include in your portfolio, it is imperative that you understand, among other things, its advantages and disadvantages.
Visit my blog at http://www.savvyfinancialtraders.com for more information, tips and advices on exchange traded funds and grab some free ebooks and e-courses along the way.
Tags: etf, ETF investment, etf trading, exchange traded funds