Skip to main content

ETF Model Solutions®

X-twitter Facebook Linkedin

Powered by ETFs

X-twitter Facebook Linkedin
Menu

What are ETFs

  • Home
  • What are ETFs

What are ETFs

As their name suggests, exchange-traded funds (ETFs) are investment funds that trade openly on securities exchanges.

ETFs are structured similarly to mutual funds in that each share that an investor purchases represents an interest in a fund that owns an underlying portfolio of securities. Investors in both mutual funds and ETFs may obtain exposure to multiple securities through a single investment, depending on the fund’s investment strategy and holdings. However, ETFs can generally be bought and sold on an exchange throughout the trading day, whereas mutual fund shares are generally purchased or redeemed based on a net asset value calculated after the close of trading.

Thus, ETFs may provide diversified investment exposure while permitting shares to be traded on an exchange during the trading day. The degree of diversification varies by ETF, and diversification does not assure a profit or protect against loss.

The following articles debunk popular myths related to ETF investing:

Commonly Used Acronyms In The ETF World:

For Exchange-Traded Fund (ETF) users and general investors alike, there are an abundance of acronyms, used regularly to define everything from groups of countries and products, to financial and trading terminology. While these terms are crucial to one’s daily understanding, it can often be difficult, confusing even, to keep track of their expanded meanings.
Here‘s a list of the most frequently used acronyms, expanded and explained, to make your everyday Wall Street Journal reading easier.

ETF Landscape Terms:

AP: Authorized Participant

An entity, usually an institutional investor, that submits orders to the ETF for the creation and redemption of ETF creation units.

LMM: Lead Market Maker

A broker-dealer firm that accepts the risk of holding a certain number of shares of a particular security in order to facilitate trading in that security.

NAV: Net Asset Value

A mutual fund’s price per share or an ETF’s per-share value.

IOPV: Indicative Optimized Portfolio Value

The IOPV is designed to give investors a sense of the relationship between a basket of securities that are representative of those owned in the ETF and the share price of the ETF on an intraday basis. Also called Indicative Value (IV).

CU: Creation Unit

A specified number of shares issued by an exchange-traded fund (ETF) in large blocks, generally between 25,000 and 200,000 shares. The authorized participants that buy creation units either keep the ETF shares that make up the creation unit or sell all or part of them on a stock exchange.

Why Use ETFs

ETFs have characteristics that may be useful to some investors depending on their investment objectives, financial circumstances, time horizon, risk tolerance, tax situation, and the characteristics of the particular ETF. ETFs also involve risks and limitations, including market risk, potential loss of principal, trading costs, bid-ask spreads, tracking differences, liquidity considerations, and depending on the fund, concentration, and other strategy-specific risks.

Potential Diversification

Some ETFs provide exposure to a broad group of securities, which may help investors diversify their portfolios. Other ETFs may be narrowly focused on particular industries, issuers, asset classes, countries, factors, or strategies and therefore may provide less diversification. Diversification does not guarantee a profit or protect against loss.

Potentially Lower Operating Expenses

Some ETFs, particularly index-based ETFs, have lower expense ratios than some actively managed investment products. Expenses vary among ETFs and other investment products, and investors should compare the actual fees and expenses of the investments under consideration. Lower expenses do not assure better investment performance.

Portfolio Turnover and Trading Costs

Some index-based ETFs may have lower portfolio turnover than certain actively managed strategies, depending on their investment objectives and methodologies. Portfolio turnover and associated transaction costs vary substantially among ETFs and other funds based on their investment strategies and trading activity. Investors in ETFs may also incur brokerage commissions, bid-ask spreads, premiums or discounts to NAV, and other trading costs.

Potential Tax Considerations

Certain ETFs may have tax characteristics that can result in fewer taxable capital-gain distributions than some other investment products in certain circumstances, in part because of their creation-and-redemption structure. ETFs can nevertheless make taxable distributions, including capital-gain distributions, and investors may incur taxable gains when ETF shares are sold. Tax consequences vary based on the ETF, account type, transaction, and investor's individual circumstances. Investors should consult their tax professionals regarding their individual situations.

Portfolio Transparency

Many ETFs provide regular information regarding their portfolio holdings. The nature and frequency of portfolio disclosure depend on the particular ETF. ETFs may be index-based or actively managed, and an ETF's performance may differ from the performance of its benchmark because of fees, expenses, trading costs, tracking differences, portfolio management decisions, and other factors.

Control of your exposure

ETFs are available across a wide range of asset classes and investment strategies, which may allow investors and advisers to select exposures suited to particular portfolio objectives. ETF holdings may overlap with holdings in other investments, and investors should evaluate their entire portfolio when assessing diversification and concentration.

Monitoring an Index-Based ETF

For an index-based ETF, the investment strategy generally seeks to track a specified index according to the methodology described in the fund's prospectus. An ETF's return may differ from the return of its underlying index because of fees, expenses, transaction costs, portfolio management techniques, tracking error, and other factors. Not all ETFs are index-based.

Trading and Rebalancing

Because ETF shares generally trade on an exchange during market hours, investors may purchase or sell shares when implementing portfolio rebalancing decisions. ETF transactions may involve commissions, bid-ask spreads, premiums or discounts to NAV, taxes, and other costs or consequences.

Intraday liquidity

ETF shares generally can be purchased and sold on an exchange during normal market hours, providing intraday trading capability. The ability to execute a transaction at a desired price is not guaranteed. ETF liquidity, trading volume, bid-ask spreads, and premiums or discounts to NAV can vary, particularly during periods of market stress.

Cash Holdings

Actively managed funds may maintain a portion of their portfolios in cash for various purposes, including maintaining liquidity or meeting shareholder redemptions. Cash holdings may affect a fund's overall investment performance because cash may earn a different return than the securities held in the fund. ETFs, including index-based ETFs, may also hold cash or cash equivalents for various purposes.

Disclosures

Investing involves risk, including the possible loss of principal. ETFs are subject to market risk and may also be subject to risks associated with their particular investment strategies, underlying securities, industries, geographic exposures, use of derivatives or leverage, liquidity, tracking of an index, and other factors. ETF shares may trade above or below their net asset value, and investors purchasing or selling ETF shares in the secondary market may incur brokerage commissions and bid-ask spreads. Diversification does not assure a profit or protect against loss. Investors should review an ETF’s prospectus and other offering documents before investing.