An ETF is a rules-based investment, generally built around an index and, as the name suggests, is traded on an exchange in the same way that you would buy and sell shares.
ETFs typically invests in a basket of assets such as shares, bonds, currencies or commodities. When you buy an ETF, you buy an interest in that fund’s basket of assets.
Most ETFs aim to track the returns from a given market index, rather than generate outperformance through active stock or asset class decisions. They provide investors with market performance (otherwise known as beta), less fees, and a diversified exposure to a specific asset class.
ETFs are open-ended funds, which means that the number of units on issue changes in response to investor demand and supply. As a result, an ETFs usually trades at or near its net asset value (NAV) of the underlying holdings. ETFs use market makers to manage the issue and redemption of units in ETFs and keep units trading close to their NAV.
ETFs have a range of attributes that have proven popular with investors worldwide:
> Diversification – ETFs provide low cost, diversified market exposure to an underlying index or asset class
> Transparency – most ETF issuers publish holdings each day
> Flexibility – ETFs trade on an exchange and can be bought and sold like shares, with investors able to place limit and stop orders
> Breadth – ETFs are available for traditional asset classes, as well as a range of sector, thematic and niche investments
> Tax efficiency – ETFs generally have lower levels of portfolio turnover and investors aren’t subject to capital gains tax triggered by the action of other investors, as is the case with most unit trust structures
> Cost efficiency – ETFs can be a cost-effective way to gain exposure to a diversified portfolio of securities. The direct costs associated with ETFs are generally lower than those associated with investment in an equivalent actively managed fund or from trading multiple securities
> Liquidity – with primary and secondary markets available to investors, ETFs can be bought and sold easily.