Exchange-traded funds (ETFs) are one of the most recent products in the market for investors who want diversification and low-cost exposure to a range of assets such as commodities, bonds, currencies or stocks.
Here Saxo Bank Group examines whether ETFs could be suitable for you.
All about ETFs
The acronym ETF stands for “exchange-traded fund” and is used to refer to standardised securities that track an index such as a stock market index, bond index or commodity index.
The fastest-growing ETF market began in 1993 when State Street Global Advisors launched SPDR S & P 500 Trust.
Over the next five years, many more were listed on US exchanges. Offering various advantages compared with conventional open-end mutual funds, ETFs have grown in popularity with investors and institutions alike, a trend that is eagerly adopted by many countries outside the US.
ETFs provide a low cost and tax-efficient way to take a position in markets or sectors that interest an investor.
For example, if there is a growing interest in commodities, particularly oil, then ETFs simplify investors to get exposure.
The price of an ETF generally tracks its underlying index pretty closely even though they are technically shares issued by the fund manager – unlike open-end mutual funds, which issue new units when demand from investors rises.
ETF supply is limited because they trade on exchanges like other securities. Besides making it easy for clients to buy and sell their ETF holdings throughout the day, this also means that ETF units may be repurchased by the manager even if they are not in demand, which helps keep their prices close underlying index.
Currency exposure is another area where ETFs can help investors allocate capital effectively. For example, if an investor wants to get exposure to Japanese equities, then investing directly through the Tokyo Stock Exchange would be costly and time-consuming for most investors. An ETF provides a more simplified way of getting quick and convenient access to this market.
Types of Investment Products
An ETF differs from other investment products such as unit trusts (mutual funds) fixed-income securities, including bonds, notes, debentures; warrants; commodities; derivatives; currencies, or futures.
ETFs are listed on exchanges, trade like other shares and can also be sold short. They can be bought either as “open-end” funds – where new units are continuously created to meet investors’ demand or as “closed-end” funds – where supply is limited or “fixed”.
When are EFTs needed?
An ETF is formed when an investment manager creates a fund that invests in an underlying asset such as stocks, commodities, bonds, or currencies. The ETF portfolio will closely track the performance of its stated benchmark index, which could include; P 500 index, Nikkei 225 Index or crude oil futures.
Consequently, the ETF price should move almost in tandem with its reference index and thus offer diversification benefits to investors. For example, if the S& P 500 index moves up by 10%, then an ETF tracking this index should increase in value by about 10%.
Unlike many other types of investments, we pegged ETF unit prices to their underlying benchmarks, which means it’s easy for investors to keep track of changes. For example, if the price of crude oil futures moves higher or lower, most ETFs associated with crude oil will follow suit.
The exception is when traded as “synthetic” products and no physical holdings in the commodity, but derivatives used instead. – these trade at a premium or discount to their benchmark due to price fluctuations in their derivative contracts.
The market witnessed various ETFs, including:
- ETFs that track individual indexes.
- Leveraged ETFs aim to achieve returns that are multiples of the index performance. Inverse ETFs deliver returns that are inversely proportional to their stated benchmark.
We also divided them into broad-based ETFs where the underlying assets are hundreds of securities, while sector-specific ones typically focus on a few stocks within an industry.
Exchange-traded funds aren’t the only investment products available to investors, but they offer many advantages over conventional investing methods.
For example, it is easy for anyone with a brokerage account to buy and sell them during market hours without paying any penalties, unlike futures contracts that have specific trading windows.
They also provide diversification benefits because one can take a position.