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 typically holds assets such as stocks (typically a mixture of investments in unit trusts and investment trusts) or bonds. Many 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 actually permitted to deal 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 comparatively recent product, having been available 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). Whereas, at some point in their brief history to date, ETFs have conventionally been the field of large and/or offshore investors, with private investors hesitant to trade in them, this trend is shifting. 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: ETF Guide.com). In 2003 assets held by ETFs in the US alone surpassed US$155 Billion.
To comprehend whether ETF investment is appropriate for you and in selecting as to which specific vehicle to comprise in your portfolio, it is crucial that you know, among other things, its pros and cons.
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