Exchange-traded funds (ETFs) are SEC-registered investment companies that offer investors a way to pool their money in a fund that invests in stocks, bonds, or other assets. In return, investors receive an interest in the fund.Most ETFs are professionally managed by SEC-registered investment advisers. Some ETFs are passively-managed funds that seek to achieve the same return as a particular market index (often called index funds), while others are actively managed funds that buy or sell investments consistent with a stated investment objective. ETFs are not mutual funds. But, they combine features of a mutual fund, which can only be purchased or redeemed at the end of each trading day at its NAV per share, with the ability to trade throughout the day on a national securities exchange at market prices.
What Is an Exchange-Traded Fund (ETF)? :-
An exchange-traded fund (ETF) is a pooled investment security that can be bought and sold like an individual stock. ETFs can be structured to track anything from the price of a commodity to a large and diverse collection of securities.
However, ETFs, like any other financial product, is not a one-size-fits-all solution. Examine them on their own merits, including management charges and commission fees, ease of purchase and sale, fit into your existing portfolio, and investment quality.
- Passive Management
ETFs are passively managed. The purpose of an ETF is to match a particular market index, leading to a fund management style known as passive management. Passive management is the chief distinguishing feature of ETFs, and it brings a number of advantages for investors in index funds. Essentially, passive management means the fund manager makes only minor, periodic adjustments to keep the fund in line with its index.
This is quite different from an actively managed fund, like most mutual funds, where the fund manager ‘actively’ manages the fund and continually trades assets in an effort to outperform the market.
- ETFs are cost-efficient
Because an ETF tracks an index without trying to outperform it, it incurs lower administrative costs than actively managed portfolios. Typical ETF administrative costs are lower than an actively managed fund, coming in less than 0.20% per annum, as opposed to the over 1% yearly cost of some actively managed mutual fund schemes. Because they have lower expense ratio, there are fewer recurring costs to diminish ETF returns.
Types of ETFs :-
- Passive ETF
Passive ETFs aim to replicate the performance of a broader index—either a diversified index such as the S&P 500 or a more specific targeted sector or trend.
- Fixed Income ETFs
These funds are designed to provide exposure to nearly every type of bond available.
- Commodity ETF
Invest in commodities like crude oil or gold. Commodity ETFs can diversify a portfolio, making it easier to hedge market downturns. Holding shares in a commodity ETF is cheaper than physical possession of the commodity.
- Currency ETF
Track the performance of currency pairs consisting of domestic and foreign currencies. Currency ETFs can be used to speculate on the prices of currencies based on political and economic developments in a country. They are also used to diversify a portfolio or as a hedge against volatility in forex markets by importers and exporters.
- Inverse ETF
Earn gains from stock declines by shorting stocks. Shorting is borrowing a stock, selling it while expecting a decline in value, and repurchasing it at a lower price. An inverse ETF uses derivatives to short a stock. Inverse ETFs are exchange-traded notes (ETNs) and not true ETFs. An ETN is a bond that trades like a stock and is backed by an issuer such as a bank.
- Industry or sector ETF
Funds that focus on a specific sector or industry. An energy sector ETF will include companies operating in that sector. Blackrock’s iShares U.S. Technology ETF (IYW) mirrors the performance of the Russell 1000 Technology RIC 22.5/45 Capped Index and holds 1374 stocks of technology sector companies.
WHAT ARE THE BENEFITS OF INVESTING IN ETFS :-
ETFs combine the range of a diversified portfolio with the simplicity of trading a single stock. Investors can purchase ETF shares on margin, short sell shares, or hold for the long term. ETFs can be bought / sold easily like any other stock on the exchange through terminals across the country.
- Cash Equitisation
Investors typically seek exposure to equity markets, but often need time to make investment decisions. ETFs provide a “Parking Place” for cash that is designated for equity investment. Because ETFs are liquid, investors can participate in the market while deciding where to invest the funds for the longer-term, thus avoiding potential opportunity costs.
Historically, investors have relied heavily on derivatives to achieve temporary exposure. However, derivatives are not always a practical solution. The large denomination of most derivative contracts can preclude investors, both institutional and individual, from using them to gain market exposure. In this case and in those where derivative use may be restricted, ETFs are a practical alternative.
- Asset Allocation
Managing asset allocation can be difficult for individual investors given the costs and assets required to achieve proper levels of diversification. ETFs provide investors with exposure to broad segments of the equity markets.
They cover a range of style and size spectrums, enabling investors to build customized investment portfolios consistent with their financial needs, risk tolerance, and investment horizon. Both institutional and individual investors use ETFs to conveniently, efficiently, and cost effectively allocate their assets.
- Trading Transactions
Since they are traded like stocks, investors can place order types (e.g., limit orders or stop-loss orders) that mutual funds cannot.
How ETFs Work :-
An ETF must be registered with the Securities and Exchange Commission. In the United States, most ETFs are set up as open-ended funds and are subject to the Investment Company Act of 1940, except where subsequent rules have modified their regulatory requirements.
The assets that are underlying are owned by the fund provider, who then forms a fund to track the performance and offers shares in that fund to investors. Shareholders own a part of an ETF but not the fund’s assets.
Here’s a quick rundown of how ETFs work.
- An ETF provider takes into account the universe of assets, such as stocks, bonds, commodities, or currencies, and builds a basket of them, each with its own ticker.
- Like a stock, buyers and sellers trade the ETF on an exchange throughout the day.
- Investors can buy a share in that basket in the same way they would buy stock in a firm.
Exchange –
ETFs are bought and sold like a common stock on a stock exchange.
Funds –
ETFs generally hold a collection of stocks, bonds or other securities in one fund or have exposure to a single stock or bond through a single-security ETF.
Traded –
Like a stock, ETFs are traded and experience price changes throughout the day.
How to Invest in ETF? :-
ETFs are available on most online investing platforms, retirement account provider sites, and investing apps like Robinhood. Most of these platforms offer commission-free trading, meaning that investors don’t have to pay fees to the platform providers to buy or sell ETFs.
After creating and funding a brokerage account, investors can search for ETFs and make their chosen buys and sells. One of the best ways to narrow ETF options is to utilize an ETF screening tool with criteria such as trading volume, expense ratio, past performance, holdings, and commission costs.
There are a few major steps to invest in an ETF-
- Open a brokerage account.
- Transfer the money.
- Choose the ETF.