Exchange traded funds review
An exchange-traded fund (ETF) is a type of financial security that follows either an index, or a commodity, or a bunch of assets like the index funds.
Differences between ETFs and indexes
Index is a list of companies selected from stock markets to represent the performance of stock markets or the specific industry. Ratio of increase or decrease in value of the consolidated bunch of stocks in the index, for a particular period, is the return generated by the index. These returns become a benchmark of returns for stock markets, or industry. They are used to assess a portfolio, company performance or mutual fund performance. Index by itself is non-tradable because its only a list of stocks. People desiring to invest in an index may have to buy each and every stock mentioned therein. Alternatively, using an external vehicle like ETF it is possible to trade indexes.
Similarly, companies dealing in gold are segregated from the market and tracked with ETFs. Companies related to commodities, metals, bullion, oil and petroleum, etc., can also be isolated from the market to form an index, and their movement can be traced with ETF shares.
In addition ETFs can be formed based on market capitalization or even bonds.
Like any other stock, price of ETF share also undergoes fluctuations during the day.
However, it is not as risky an investment as investing in individual shares of a particular industry.
Major differences between shares of ETF and shares of mutual funds are:
- The net asset value of mutual fund share is calculated at the end of the day after considering the day's transactions and dividing the profits or losses by total number of shares making the fund.
Price of ETF, on the other hand, moves like any other share price, during the day. And the closing price at the end of the day is the price of ETF for the day. There are no further calculations involved.
- Professionals manage shares in mutual funds.
ETF shares are generally self-managed.
- Every mutual fund stipulates the minimum subscription amount, which entitles the investor to a minimum number of shares in the mutual fund.
ETF has no such restriction. Even a single share of ETF can be purchased.
- Mutual fund shares cannot be traded in derivative method. That is, there can be no call or put, or long or short of these shares.
ETF shares can be traded like derivatives, i.e., they can be sold long or short, bought on margins or cash, etc.
- There may be exit and entry loads associated with mutual funds.
ETF on the other hand has no such entry and exit loads. Other than brokerage charges, there are very few costs associated with ETFs.
- Shares of mutual funds do not have brokerage charges.
Buying and selling ETF shares entails brokerage charges.
- There is a range of shares that underlie mutual fund shares. Therefore, even if one or two of such underlying shares rapidly scale new heights, the mutual fund shares do not show the same ratio of spike. This is because, each share of mutual fund shares also represents the value of other underlying shares that have not moved much or have even dipped. At the end of the day, it is only the weighted average spike in value that is seen in net asset values of mutual fund shares.
ETF shares mimic the movement of specific indices, or a commodity or a bunch of investments in index funds. Any spike in these underlying indices, commodities, etc., is reflected in equal ratio or even more.
- Investments in mutual funds are less risky because of their diversified underlying portfolios.
In comparison, investments in ETF are more risky because they track only a single commodity, or a single index.
Therefore, profits and losses on investments in mutual funds shares are lower than those in ETF shares.
- There are no in-kind redemptions in mutual funds shares.
ETF shares can be redeemed in-kind i.e., in form of any shares that form part of the index that the ETF tracks. Thus, ETF can be used as tax planning tool.
- Expenses in mutual funds are high, as individual stocks have to be bought and sold to book profits. This means brokerage commissions on multiple transactions.
Since ETF covers all such transactions within few transactions, brokerage commissions are lesser. Therefore, expense ratios when compared to mutual funds, are much lower in ETF.
Normally ETFs track indexes prepared by NASDAQ, Dow Jones and Standard & Poors.
Most common ETFs are:
- SPDRS or SPIDERS as they are commonly known refer to the bunch of ETF's that track indexes from Standard and Poors.
Salient features - It does away with the necessity of buying 500 stocks on S&P 500 to get the required rate of return. ETF's are also available that are based on sector wise division of S&P 500.
Ticker symbol - SPY
Trades on AMEX
- DIAMONDS Trust Series are a bunch of ETF's that follow the Dow Jones Industrial Average.
Salient features: - Diamonds are more like unit investment trust.
Ticker symbol - DIA
Trades on AMEX
- iShares refers to a group of ETF's under Barclay's Global Investors brand. These ETFs track various indexes, like the technology-oriented iShares tracks indexes from Goldman Sachs.
Salient features - can be traded internationally.
Ticker symbols - IYY, IWV, IWZ, IWW, ISI
Trades on many stock exchanges across the world. NASDAQ and
Amex in America
- Vipers is an acronym for Vanguard Index Participation Receipts. As the name indicates, these are ETFs under Vanguard's brand.
Salient features - basically open end funds with many share classes. These shares relate to many different industries like healthcare, textiles, technology, finance, etc.
Ticker symbols - VTR or VXF
Traded on Amex
- Nasdaq - 100 index Tracking Stock is a single ETF.
Salient features - The ETF focuses on technology stock. It dispenses with the need to buy any of the 100 stocks that underlie the Nasdaq 100, and also reduces the risks with such diversification.
Ticker symbol - QQQQ
Traded on NASDAQ
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