All You Need To Know About Exchange-Traded Funds

All You Need To Know About Exchange-Traded Funds
Underwater by Andy Deitsch. Why?

Exchange-traded funds (ETFs) have seen phenomenal growth over the past decade, so here’s a summary of what they are and how they work

With Trillions Under Management, Exchange-Traded Funds Have Become The Backbone Of The Passive Funds Industry

A Quick Guide To Exchange-Traded Funds

Exchange-traded funds become a popular, low cost investment vehicle found throughout the world, having originally been thought of as an American institutional investment product.

There’s a huge product range available, with exchange-traded funds tracking commodities, smart-beta strategies and sector-specific indices.

According to the Financial Times, exchange traded funds (ETFs) offer the chance to capture the returns of a whole index, but how do they work?  In the short video below, Financial Times’ senior investment columnist, John Authers, explains how they operate and what risks investors could face.

ETF exchange-traded fund

Exchange-Traded Funds Are A Big Part Of Passive Investing

The video below outlines how exchange-traded funds are becoming an increasingly important part of portfolio construction, and how rising fees within the active funds market are delivering a killer blow to the industry.

ETF exchange-traded fund

How Exchange-Traded Funds Work

In the most basic sense, an exchange-traded fund is a type of fund that owns assets such as stocks, commodities, or futures, but has its ownership divided into shares that trade on stock exchanges.

In other words, investors can buy and sell exchange-traded funds whenever they want during trading hours. 

Like a stock, each exchange-traded fund has a ticker symbol and a price that changes in real time. 

However, unlike a stock, the number of shares outstanding can change daily based on the share creation and redemption mechanisms.

It’s generally accepted that exchange-traded funds provide an inexpensive, transparent, and convenient way to get access to many different asset classes. 

This makes it easy to diversify a portfolio. 

And it’s simple to buy and sell exchange-traded funds.

As a consequence, the passive management investment industry has taken off big style.

The exchange-traded fund industry now has over $4 trillion of assets under management globally.  This is expected to surpass $7 trillion by the year 2021.

Despite this growth and a wide range of benefits, exchange-traded funds do have some detractors.

Critics would point out that some exchange-traded funds are very thinly traded, providing wide bid to offer spreads and lower liquidity.  Furthermore, there can also be instances where technical issues can cause a performance gap between the exchange-traded fund and the index it tracks, known as tracking error.

There could also be some counterparty risk with exchange-traded funds.  In extreme situations, the counterparty risk stems from the possibility of a party failing to deliver on its promises, something that’s quite common with other types of assets.

Guide To Exchange-Traded Funds

With contributions from Nutmeg, iShares, Invesco Powershares, ETFMatic, Vanguard and Lumin Wealth, FTAdviser has produced a comprehensive look at the subject of exchange traded funds. 

It’s arranged in four sections:

1. How the EFT market has grown ~ Exchange-Traded Funds

2. ETFs vs index funds and the rise of smart beta ~ Exchange-Traded Funds

3. How to use ETFs in portfolio construction ~ Exchange-Traded Funds

4. ETF developments in 2017 and beyond ~ Exchange-Traded Funds

What Is An Exchange-Traded Fund?

ETF exchange-traded fund

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