Exchange Traded Funds (ETFs)

An Exchange Traded Fund (ETF) is a pooled investment vehicle with shares that can be bought and sold throughout the day on the stock exchange, in the same way that ordinary stocks and shares are traded.

Exchange Traded Commodities (ETCs) are listed debt instruments traded on a stock exchange and backed by a commodity. They are not funds or ETFs.

Similarities

• Both offer diversified exposure to main asset classes
• Both are open-ended

Differences

• ETFs can be bought via a stockbroker or trading platform, whereas mutual funds are bought via a fund management company. 
• ETFs can be bought at any time during the day, when the exchange is open, whereas mutual funds are once per day.
• ETFs are priced throughout the day, compared to mutual funds which are usually priced once per day. 
• ETFs are highly transparent, whereas it varies with mutual funds. 

Benefits:

Low cost of ownership – ETFs tend to be cheaper than most other funds.  

Liquidity – Creation/redemption process ensures liquidity

Ease of trading – ETFs can be traded on a stock exchange at any time, when open. May be an attractive feature for investors who are looking for more flexibility around when to buy and sell an investment.

Transparency – ETFs are very transparent and usually disclose their full list of holdings daily on the ETF provider’s website.

Index tracking – Physical and synthetic replication models may offer economic advantages

Risks:

Tracking differences: ETFs may not track an index perfectly. The difference between fund return and index return is called ‘tracking difference’.

Capital risk: Like any investment product, the value of an ETF may go down as well as up, and you may not get back the amount invested.

You would typically buy and sell ETFs through a stockbroker or online trading platform, just like ordinary stocks and shares.

While buying and selling our ETFs is usually quite straightforward, you may wish to seek professional advice especially if you have a particularly large or complex trade.

There are many ways for fund managers to track the performance of an index. These ‘replication methods’ fall into two broad categories, physical and synthetic.

Physical ETFs own the underlying stocks or bonds that comprise the benchmark index; whereas a synthetic ETF aims to deliver the index performance through a swap provided by an investment bank. A swap is a type of derivative contract where two parties agree to exchange (“swap”) one stream of flows for another.  

Smart beta is a term for any rules-based strategy that uses characteristics other than just geography and market capitalisation to select and weight the securities of the index.