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An exchange-traded fund (ETF) is a type of
investment fund An investment fund is a way of investing money alongside other investors in order to benefit from the inherent advantages of working as part of a group such as reducing the risks of the investment by a significant percentage. These advantages inc ...
and exchange-traded product, i.e. they are traded on
stock exchange A stock exchange, securities exchange, or bourse is an exchange where stockbrokers and traders can buy and sell securities, such as shares of stock, bonds and other financial instruments. Stock exchanges may also provide facilities for t ...
s. ETFs are similar in many ways to mutual funds, except that ETFs are bought and sold from other owners throughout the day on
stock exchange A stock exchange, securities exchange, or bourse is an exchange where stockbrokers and traders can buy and sell securities, such as shares of stock, bonds and other financial instruments. Stock exchanges may also provide facilities for t ...
s whereas mutual funds are bought and sold from the issuer based on their price at day's end. An ETF holds assets such as
stock In finance, stock (also capital stock) consists of all the shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especially AmE'' one of the shares into which ownership of a compan ...
s,
bond Bond or bonds may refer to: Common meanings * Bond (finance), a type of debt security * Bail bond, a commercial third-party guarantor of surety bonds in the United States * Chemical bond, the attraction of atoms, ions or molecules to form chemical ...
s, currencies, futures contracts, and/or
commodities In economics, a commodity is an economic good, usually a resource, that has full or substantial fungibility: that is, the market treats instances of the good as equivalent or nearly so with no regard to who produced them. The price of a co ...
such as
gold bar A gold bar, also called gold bullion or gold ingot, is a quantity of refined metallic gold of any shape that is made by a bar producer meeting standard conditions of manufacture, labeling, and record keeping. Larger gold bars that are produced ...
s, and generally operates with an
arbitrage In economics and finance, arbitrage (, ) is the practice of taking advantage of a difference in prices in two or more markets; striking a combination of matching deals to capitalise on the difference, the profit being the difference between t ...
mechanism designed to keep it trading close to its net asset value, although deviations can occasionally occur. Most ETFs are
index fund An index fund (also index tracker) is a mutual fund or exchange-traded fund (ETF) designed to follow certain preset rules so that the fund can a specified basket of underlying investments.Reasonable Investor(s), Boston University Law Review, avai ...
s: that is, they hold the same securities in the same proportions as a certain
stock market index In finance, a stock index, or stock market index, is an index that measures a stock market, or a subset of the stock market, that helps investors compare current stock price levels with past prices to calculate market performance. Two of th ...
or bond market index. The most popular ETFs in the U.S. replicate the
S&P 500 The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. As of ...
, the total market index, the
NASDAQ-100 The Nasdaq-100 (^NDX) is a stock market index made up of 101 equity securities issued by 100 of the largest non-financial companies listed on the Nasdaq stock exchange. It is a modified capitalization-weighted index. The stocks' weights in the in ...
index, the price of gold, the "growth" stocks in the
Russell 1000 Index The Russell 1000 Index is a stock market index that tracks the highest-ranking 1,000 stocks in the Russell 3000 Index, which represent about 93% of the total market capitalization of that index. , the stocks of the Russell 1000 Index had a weig ...
, or the index of the largest technology companies. With the exception of non-transparent actively managed ETFs, in most cases, the list of stocks that each ETF owns, as well as their weightings, is posted daily on the website of the issuer. The largest ETFs have annual fees of 0.03% of the amount invested, or even lower, although specialty ETFs can have annual fees well in excess of 1% of the amount invested. These fees are paid to the ETF issuer out of
dividend A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-i ...
s received from the underlying holdings or from selling assets. An ETF divides ownership of itself into
shares In financial markets, a share is a unit of equity ownership in the capital stock of a corporation, and can refer to units of mutual funds, limited partnerships, and real estate investment trusts. Share capital refers to all of the shares of ...
that are held by shareholders. The details of the structure (such as a corporation or trust) will vary by country, and even within one country there may be multiple possible structures. The shareholders indirectly own the assets of the fund, and they will typically get
annual report An annual report is a comprehensive report on a company's activities throughout the preceding year. Annual reports are intended to give shareholders and other interested people information about the company's activities and financial performance. ...
s. Shareholders are entitled to a share of the profits, such as interest or dividends, and they would be entitled to any residual value if the fund undergoes
liquidation Liquidation is the process in accounting by which a company is brought to an end in Canada, United Kingdom, United States, Ireland, Australia, New Zealand, Italy, and many other countries. The assets and property of the company are redistrib ...
. ETFs may be attractive as investments because of their low costs, tax efficiency, and tradability. As of August 2021, $9 trillion was invested in ETFs globally, including $6.6 trillion invested in the U.S. In the U.S., the largest ETF issuers are
BlackRock BlackRock, Inc. is an American multi-national investment company based in New York City. Founded in 1988, initially as a risk management and fixed income institutional asset manager, BlackRock is the world's largest asset manager, with trill ...
iShares with a 35% market share,
The Vanguard Group The Vanguard Group, Inc. is an American registered investment advisor based in Malvern, Pennsylvania, with about $7 trillion in global assets under management, as of January 13, 2021. It is the largest provider of mutual funds and the second-l ...
with a 28% market share,
State Street Global Advisors State Street Global Advisors (SSGA) is the investment management division of State Street Corporation and the world's fourth largest asset manager, with nearly $4.14 trillion (USD) in assets under management as of 31 December 2021. The comp ...
with a 14% market share,
Invesco Invesco Ltd. is an American independent investment management company that is headquartered in Atlanta, Georgia, with additional branch offices in 20 countries. Its common stock is a constituent of the S&P 500 and trades on the New York stock exc ...
with a 5% market share, and Charles Schwab Corporation with a 4% market share.
Closed-end fund A closed-end fund (CEF) is a fund that raises capital by issuing a fixed number of shares which are not redeemable, and then invest that capital in financial assets such as stocks and bonds. Unlike open-end funds, new shares in a closed-end fund ...
s are not considered to be ETFs, even though they are funds and are traded on an exchange.
Exchange-traded note An exchange-traded product (ETP) is a regularly priced security which trades during the day on a national stock exchange. ETPs may embed derivatives but it is not a requirement that they do so - and the investment memorandum (or offering documents ...
s are debt instruments that are not exchange-traded funds.


Investment uses and benefits

Among the advantages of ETFs are the following, some of which derive from the status of most ETFs as index funds:


Costs

Since most ETFs are
index fund An index fund (also index tracker) is a mutual fund or exchange-traded fund (ETF) designed to follow certain preset rules so that the fund can a specified basket of underlying investments.Reasonable Investor(s), Boston University Law Review, avai ...
s, they incur low
expense ratio The expense ratio of a stock or asset fund is the total percentage of fund assets used for administrative, management, advertising (12b-1), and all other expenses. An expense ratio of 1% per annum means that each year 1% of the fund's total assets ...
s because they are not actively managed. An index fund is much simpler to run, since it does not require security selection, and can be done largely by computer. Unlike
mutual fund A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICA ...
s, ETFs do not have to buy and sell securities to accommodate shareholder purchases and redemptions. And thus, an ETF does not have to maintain a cash reserve for redemptions and saves on brokerage expenses. ETFs typically have extremely low marketing, distribution and accounting expenses, and most ETFs do not have 12b-1 fees. Over the long term, these cost differences can compound into a noticeable difference. However, some mutual funds are
index fund An index fund (also index tracker) is a mutual fund or exchange-traded fund (ETF) designed to follow certain preset rules so that the fund can a specified basket of underlying investments.Reasonable Investor(s), Boston University Law Review, avai ...
s as well and also have very low expense ratios, and some specialty ETFs have high expense ratios. To the extent a stockbroker charges brokerage commissions, because ETFs trade on
stock exchange A stock exchange, securities exchange, or bourse is an exchange where stockbrokers and traders can buy and sell securities, such as shares of stock, bonds and other financial instruments. Stock exchanges may also provide facilities for t ...
s, each transaction may be subject to a brokerage commission. In addition, sales of ETFs in the United States are subject to transaction fees that the national securities exchanges must pay to the SEC under section 31 of the
Securities Exchange Act of 1934 The Securities Exchange Act of 1934 (also called the Exchange Act, '34 Act, or 1934 Act) (, codified at et seq.) is a law governing the secondary trading of securities ( stocks, bonds, and debentures) in the United States of America. A land ...
, currently 0.00221% of the net proceeds from the transaction. Mutual funds are not subject to commissions and SEC fees; however, some mutual funds charge front-end or back-end loads, while ETFs do not have loads at all.


Taxation

ETFs are structured for tax efficiency and can be more attractive tax-wise than mutual funds. Unless the investment is sold, ETFs generally generate no
capital gains tax A capital gains tax (CGT) is the tax on profits realized on the sale of a non-inventory asset. The most common capital gains are realized from the sale of stocks, bonds, precious metals, real estate, and property. Not all countries impose a c ...
es, because they typically have low turnover of their portfolio securities. While this is an advantage they share with other index funds, their tax efficiency compared to
mutual fund A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICA ...
s is further enhanced because ETFs do not have to sell securities to meet investor redemptions. In the U.S., whenever a mutual fund realizes a
capital gain Capital gain is an economic concept defined as the profit earned on the sale of an asset which has increased in value over the holding period. An asset may include tangible property, a car, a business, or intangible property such as shares. A ...
that is not balanced by a realized loss, the mutual fund must "distribute" the capital gains to its shareholders and the shareholders must pay
capital gains tax A capital gains tax (CGT) is the tax on profits realized on the sale of a non-inventory asset. The most common capital gains are realized from the sale of stocks, bonds, precious metals, real estate, and property. Not all countries impose a c ...
es on the amount of the gain (unless such investment is held in an individual retirement account), even if the distribution is reinvested. This can happen whenever the mutual fund sells portfolio securities, whether to reallocate its investments or to fund shareholder redemptions. In contrast, ETFs are not redeemed by investors; any investor who wants to liquidate generally would sell the ETF shares on the
secondary market The secondary market, also called the aftermarket and follow on public offering, is the financial market in which previously issued financial instruments such as stock, bonds, options, and futures are bought and sold. The initial sale of the ...
, so investors generally only realize
capital gain Capital gain is an economic concept defined as the profit earned on the sale of an asset which has increased in value over the holding period. An asset may include tangible property, a car, a business, or intangible property such as shares. A ...
s when they sell their own shares for a gain. In most cases, ETFs are more tax-efficient than mutual funds in the same asset classes or categories. An exception is some ETFs offered by
The Vanguard Group The Vanguard Group, Inc. is an American registered investment advisor based in Malvern, Pennsylvania, with about $7 trillion in global assets under management, as of January 13, 2021. It is the largest provider of mutual funds and the second-l ...
, which are simply a different share class of their mutual funds. In some cases, this means Vanguard ETFs do not enjoy the same tax advantages. In other cases, Vanguard uses the ETF structure to let the entire fund defer capital gains, benefiting both the ETF holders and mutual fund holders. In the United Kingdom, ETFs can be shielded from
capital gains tax A capital gains tax (CGT) is the tax on profits realized on the sale of a non-inventory asset. The most common capital gains are realized from the sale of stocks, bonds, precious metals, real estate, and property. Not all countries impose a c ...
by investing in them via an
Individual Savings Account An individual savings account (ISA; ) is a class of retail investment arrangement available to residents of the United Kingdom. First introduced in 1999, the accounts have favourable tax status. Payments into the account are made from after-tax i ...
(ISA) or
Self-Invested Personal Pension A self-invested personal pension (SIPP) is the name given to the type of UK government-approved personal pension scheme which allows individuals to make their own investment decisions from the full range of investments approved by HM Revenue and ...
(SIPP), in the same manner as many other shares. Because UK-resident ETFs would be liable for UK corporation tax on non-UK dividends, most ETFs which hold non-UK companies sold to UK investors are issued in Ireland or Luxembourg. The tax efficiency of ETFs are of no relevance for investors using tax-deferred accounts or investors who are tax-exempt, such as certain nonprofit organizations.


Trading

ETFs can be bought and sold at current market prices at any time during the trading day, unlike mutual funds and unit investment trusts, which can only be traded at the end of the trading day. Also unlike mutual funds, since ETFs are publicly traded securities, investors can execute the same types of trades that they can with a stock, such as
limit order An order is an instruction to buy or sell on a trading venue such as a stock market, bond market, commodity market, financial derivative market or cryptocurrency exchange. These instructions can be simple or complicated, and can be sent to either ...
s, which allow investors to specify the price points at which they are willing to trade, stop-loss orders, margin buying, hedging strategies, and there is no minimum investment requirement. Because ETFs can be cheaply acquired, held, and disposed of, some investors buy and hold ETFs for asset allocation purposes, while other investors trade ETF shares frequently to
hedge A hedge or hedgerow is a line of closely spaced shrubs and sometimes trees, planted and trained to form a barrier or to mark the boundary of an area, such as between neighbouring properties. Hedges that are used to separate a road from adjoi ...
risk or implement
market timing Market timing is the strategy of making buying or selling decisions of financial assets (often stocks) by attempting to predict future market price movements. The prediction may be based on an outlook of market or economic conditions resulting fr ...
investment strategies.
Options Option or Options may refer to: Computing *Option key, a key on Apple computer keyboards *Option type, a polymorphic data type in programming languages *Command-line option, an optional parameter to a command *OPTIONS, an HTTP request method ...
, including
put option In finance, a put or put option is a derivative instrument in financial markets that gives the holder (i.e. the purchaser of the put option) the right to sell an asset (the ''underlying''), at a specified price (the ''strike''), by (or at) a ...
s and
call option In finance, a call option, often simply labeled a "call", is a contract between the buyer and the seller of the call option to exchange a security at a set price. The buyer of the call option has the right, but not the obligation, to buy ...
s, can be written or purchased on most ETFs – which is not possible with mutual funds. Covered call strategies allow investors and traders to potentially increase their returns on their ETF purchases by collecting premiums (the proceeds of a call sale or write) on call options written against them. There are also ETFs that use the covered call strategy to reduce volatility and simplify the covered call process.


Market exposure and diversification

If they track a broad index, ETFs can provide some level of
diversification Diversification may refer to: Biology and agriculture * Genetic divergence, emergence of subpopulations that have accumulated independent genetic changes * Agricultural diversification involves the re-allocation of some of a farm's resources to n ...
. Like many mutual funds, ETFs provide an economical way to rebalance portfolio allocations and to invest cash quickly. An index ETF inherently provides diversification across an entire index, which can include broad-based international and country-specific indices, industry sector-specific indices, bond indices, and commodities.


Transparency

The SEC generally requires ETFs to be transparent and issuers generally are required to publish the composition of the ETF portfolios daily on their websites. However, the SEC does allow certain actively managed ETFs to be non-transparent - i.e. they do not have to disclose exactly what they own. ETFs are priced continuously throughout the trading day and therefore have price transparency.


Types

In the United States, most ETFs are structured as open-end management investment companies, the same structure used by mutual funds and money market funds, although a few ETFs, including some of the largest ones, are structured as
unit investment trust In U.S. financial law, a unit investment trust (UIT) is an investment product offering a fixed (unmanaged) portfolio of securities having a definite life. Unlike open-end and closed-end investment companies, a UIT has no board of directors. A ...
s. ETFs structured as open-end funds have greater flexibility in constructing a portfolio and are not prohibited from participating in securities lending programs or from using futures and options in achieving their investment objectives.


Index ETFs

Most ETFs are
index fund An index fund (also index tracker) is a mutual fund or exchange-traded fund (ETF) designed to follow certain preset rules so that the fund can a specified basket of underlying investments.Reasonable Investor(s), Boston University Law Review, avai ...
s that attempt to replicate the performance of a specific
index Index (or its plural form indices) may refer to: Arts, entertainment, and media Fictional entities * Index (''A Certain Magical Index''), a character in the light novel series ''A Certain Magical Index'' * The Index, an item on a Halo megastru ...
. Indexes may be based on the values of
stock In finance, stock (also capital stock) consists of all the shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especially AmE'' one of the shares into which ownership of a compan ...
s, bonds,
commodities In economics, a commodity is an economic good, usually a resource, that has full or substantial fungibility: that is, the market treats instances of the good as equivalent or nearly so with no regard to who produced them. The price of a co ...
, or currencies. An index fund seeks to track the performance of an index by holding in its portfolio either the contents of the index or a representative sample of the securities in the index. Many funds track U.S. stock market indexes; for example, Vanguard Total Stock Market ETF () tracks the CRSP U.S. Total Market Index, and ETFs that track the
S&P 500 The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. As of ...
are issued by
The Vanguard Group The Vanguard Group, Inc. is an American registered investment advisor based in Malvern, Pennsylvania, with about $7 trillion in global assets under management, as of January 13, 2021. It is the largest provider of mutual funds and the second-l ...
(), iShares (), and State Street Corporation (). Other funds track international stock indexes; for example, Vanguard Total International Stock Index () tracks the MSCI All Country World ex USA Investable Market Index, while the iShares
MSCI EAFE The MSCI EAFE Index is a stock market index that is designed to measure the equity market performance of developed markets outside of the U.S. & Canada. It is maintained by MSCI Inc., a provider of investment decision support tools; the EAFE acro ...
Index () tracks the
MSCI EAFE The MSCI EAFE Index is a stock market index that is designed to measure the equity market performance of developed markets outside of the U.S. & Canada. It is maintained by MSCI Inc., a provider of investment decision support tools; the EAFE acro ...
Index, both invest solely in companies that are not based in the United States. Many smaller ETFs use unknown, untested indices. ETFs replicate indexes and such indexes have varying investment criteria, such as minimum or maximum
market capitalization Market capitalization, sometimes referred to as market cap, is the total value of a publicly traded company's outstanding common shares owned by stockholders. Market capitalization is equal to the market price per common share multiplied by ...
of each holding. For example, the
S&P 500 The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. As of ...
only contains large- and mid-cap stocks, so any ETF that tracks this index will not contain small-capitalization stocks. Others such as iShares
Russell 2000 Index The Russell 2000 Index is a small-cap stock market index that makes up the smallest 2,000 stocks in the Russell 3000 Index. It was started by the Frank Russell Company in 1984. The index is maintained by FTSE Russell, a subsidiary of the Lon ...
replicate an index composed only of small-cap stocks. There are many style ETFs such as iShares Russell 1000 Growth and iShares Russell 1000 Value. The iShares Select Dividend ETF replicates an index of high dividend paying stocks. Other indexes, on which ETFs are based, focus on a specific industry, such as banks or technology, or specific niche areas, such as
sustainable energy Energy is sustainable if it "meets the needs of the present without compromising the ability of future generations to meet their own needs". Most definitions of sustainable energy include considerations of environmental aspects such as green ...
or environmental, social and corporate governance. They can also focus on stocks in one country or be global. There are also ETFs, such as Factor ETFs, that use enhanced indexing, which is an attempt to slightly beat the performance of an index using
active management Active management (also called ''active investing'') is an approach to investing. In an actively managed portfolio of investments, the investor selects the investments that make up the portfolio. Active management is often compared to passive ma ...
. Exchange-traded funds that invest in bonds are known as bond ETFs. Government bond ETFs thrive during economic recessions because investors sell stocks and buy safer treasury bonds. Bond ETFs generally have much more market liquidity than individual bonds. Some index ETFs invest 100% of their assets proportionately in the securities underlying an index, a manner of investing called replication. Other index ETFs such as the Vanguard Total Stock Market Index Fund, use representative sampling, investing 80% to 95% of their assets in the securities of an underlying index and investing the remaining 5% to 20% of their assets in other holdings, such as futures, option and swap contracts, and securities not in the underlying index, that the fund's adviser believes will help the ETF to achieve its investment objective. There are various ways the ETF can be weighted, such as equal weighting or revenue weighting. For index ETFs that invest in indices with thousands of underlying securities, some index ETFs employ "aggressive sampling" and invest in only a tiny percentage of the underlying securities. Some index ETFs, such as leveraged ETFs or inverse ETFs, use investments in derivatives to seek a return that corresponds to a multiple of, or the inverse (opposite) of, the daily performance of the index.


Commodity ETFs

Commodity ETFs invest in
commodities In economics, a commodity is an economic good, usually a resource, that has full or substantial fungibility: that is, the market treats instances of the good as equivalent or nearly so with no regard to who produced them. The price of a co ...
such as precious metals, agricultural products, or hydrocarbons such as petroleum. They are similar to ETFs that invest in securities, and trade just like shares; however, because they do not invest in securities, commodity ETFs are not regulated as investment companies under the
Investment Company Act of 1940 The Investment Company Act of 1940 (commonly referred to as the '40 Act) is an act of Congress which regulates investment funds. It was passed as a United States Public Law () on August 22, 1940, and is codified at . Along with the Securities Ex ...
in the United States, although their public offering is subject to review by the U.S. Securities and Exchange Commission (SEC) and they need an SEC
no-action letter A no-action letter is a letter written by the staff members of a government agency, requested by an entity subject to regulation by that agency, indicating that the staff will not recommend that the agency take legal action against the entity, sh ...
under the
Securities Exchange Act of 1934 The Securities Exchange Act of 1934 (also called the Exchange Act, '34 Act, or 1934 Act) (, codified at et seq.) is a law governing the secondary trading of securities ( stocks, bonds, and debentures) in the United States of America. A land ...
. They may, however, be subject to regulation by the
Commodity Futures Trading Commission The Commodity Futures Trading Commission (CFTC) is an independent agency of the US government created in 1974 that regulates the U.S. derivatives markets, which includes futures, swaps, and certain kinds of options. The Commodity Exchange Act ...
. Commodity ETFs are generally structured as exchange-traded grantor trusts, which gives a direct interest in a fixed portfolio. SPDR Gold Shares, a
gold exchange-traded fund Gold exchange-traded products are exchange-traded funds (ETFs), closed-end funds (CEFs) and exchange-traded notes (ETNs) that are used to own gold as an investment. Gold exchange-traded products are traded on the major stock exchanges including th ...
, is a grantor trust, and each share represents ownership of one-tenth of an ounce of gold. Most commodity ETFs own the physical commodity. SPDR Gold Shares () owns over 40 million ounces of gold in trust, iShares Silver Trust () owns 18,000 tons of silver, Aberdeen Standard Physical Palladium Shares () owns almost 200,000 ounces of
palladium Palladium is a chemical element with the symbol Pd and atomic number 46. It is a rare and lustrous silvery-white metal discovered in 1803 by the English chemist William Hyde Wollaston. He named it after the asteroid Pallas, which was itself ...
, and Aberdeen Standard Physical Platinum Shares ETF () owns over 1.1 million ounces of
platinum Platinum is a chemical element with the symbol Pt and atomic number 78. It is a dense, malleable, ductile, highly unreactive, precious, silverish-white transition metal. Its name originates from Spanish , a diminutive of "silver". Pla ...
. However, many ETFs such as the
United States Oil Fund The United States Oil Fund () is an exchange-traded fund (ETF) that attempts to track the price of West Texas Intermediate Light Sweet Crude Oil. It is distinguished from an exchange-traded note (ETN) since it represents an ownership claim on u ...
by United States Commodity Funds () only own futures contracts, which may produce quite different results from owning the commodity. In these cases, the funds simply roll the delivery month of the contracts forward from month to month. This does give exposure to the commodity, but subjects the investor to risks involved in different prices along the term structure, such as a high cost to roll. They can also be index funds tracking commodity indices.


Currency ETFs

Currency ETFs enable investors to invest in or short any major currency or a basket of currencies. They are issued by
Invesco Invesco Ltd. is an American independent investment management company that is headquartered in Atlanta, Georgia, with additional branch offices in 20 countries. Its common stock is a constituent of the S&P 500 and trades on the New York stock exc ...
and
Deutsche Bank Deutsche Bank AG (), sometimes referred to simply as Deutsche, is a German multinational investment bank and financial services company headquartered in Frankfurt, Germany, and dual-listed on the Frankfurt Stock Exchange and the New York St ...
among others. Investors can profit from the foreign exchange spot change, while receiving local institutional interest rates, and a collateral yield.


Actively managed ETFs

While most ETFs are
index fund An index fund (also index tracker) is a mutual fund or exchange-traded fund (ETF) designed to follow certain preset rules so that the fund can a specified basket of underlying investments.Reasonable Investor(s), Boston University Law Review, avai ...
s, some ETFs, particularly bond ETFs, do have
active management Active management (also called ''active investing'') is an approach to investing. In an actively managed portfolio of investments, the investor selects the investments that make up the portfolio. Active management is often compared to passive ma ...
. Actively managed ETFs are usually fully transparent, publishing their current securities portfolios on their websites daily. But some actively managed ETFs are not fully transparent. A transparent actively managed ETF is at risk from arbitrage activities by people who might engage in
front running Front running, also known as tailgating, is the prohibited practice of entering into an equity ( stock) trade, option, futures contract, derivative, or security-based swap to capitalize on advance, nonpublic knowledge of a large ("block") pend ...
since the daily portfolio reports can reveal the manager's trading strategy. Some actively managed equity ETFs address this problem by trading only weekly or monthly. Actively managed debt ETFs, which are less susceptible to front-running, trade more frequently. Actively managed bond ETFs are not at much of a disadvantage to bond market index funds since concerns about disclosing bond holdings are less pronounced and there are fewer product choices. The largest actively managed ETFs, each bond ETFs with approximately $14 billion in assets, are the JPMorgan Ultra-Short Income ETF (), which charges 0.18% in annual fees, and the
Pimco PIMCO (Pacific Investment Management Company, LLC) is an American investment management firm focusing on active fixed income management worldwide. PIMCO manages investments in many asset classes such as fixed income, equities, commodities, a ...
Enhanced Short Duration ETF (), which charges 0.36% in annual fees. Actively managed ETFs compete with actively managed mutual funds. While both seek to outperform the market or their benchmark and rely on portfolio managers to choose which stocks and bonds the funds will hold, there are four major ways they differ. Unlike actively managed mutual funds, actively managed ETFs trade on a stock exchange, can be sold short, can be purchased on margin and have a tax-efficient structure.


Inverse ETFs

Inverse ETFs are constructed by using various derivatives for the purpose of profiting from a decline in the value of the underlying benchmark or index. It is a similar type of investment to holding several short positions or using a combination of advanced investment strategies to profit from falling prices. Many inverse ETFs use daily futures as their underlying benchmark.


Leveraged ETFs

Leveraged exchange-traded funds (LETFs or leveraged ETFs) attempt to achieve daily returns that are a multiple of the returns of the corresponding index. Leveraged index ETFs are often marketed as bull or bear funds. For example, a leveraged bull ETF fund might attempt to achieve daily returns that are 2x or 3x those of the
Dow Jones Industrial Average The Dow Jones Industrial Average (DJIA), Dow Jones, or simply the Dow (), is a stock market index of 30 prominent companies listed on stock exchanges in the United States. The DJIA is one of the oldest and most commonly followed equity inde ...
or the
S&P 500 The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. As of ...
. A leveraged
inverse exchange-traded fund An inverse exchange-traded fund is an exchange-traded fund (ETF), traded on a public stock market, which is designed to perform as the ''inverse'' of whatever index or benchmark it is designed to track. These funds work by using short selling, t ...
may attempt to achieve returns that are -2x or -3x the daily index return, meaning that it will gain double or triple the loss of the market. To achieve these results, the issuers use various financial engineering techniques, including equity swaps, derivatives, futures contracts, and rebalancing, and re-indexing. Direxion offers leveraged ETFs that attempt to produce 3x the daily result of either investing in () or shorting () the
S&P 500 The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. As of ...
. The rebalancing and re-indexing of leveraged ETFs may have considerable costs when markets are volatile. Leveraged ETFs effectively increase exposure ahead of a losing session and decrease exposure ahead of a winning session. The rebalancing problem is that the fund manager incurs trading losses because he needs to buy when the index goes up and sell when the index goes down in order to maintain a fixed leverage ratio. A 2.5% daily change in the index will for example reduce value of a -2x bear fund by about 0.18% per day, which means that about a third of the fund may be wasted in trading losses within a year (1-(1-0.18%)252=36.5%). Investors may however circumvent this problem by buying or writing futures directly, accepting a varying leverage ratio. A more reasonable estimate of daily market changes is 0.5%, which leads to a 2.6% yearly loss of principal in a 3x leveraged fund. The re-indexing problem of leveraged ETFs stems from the arithmetic effect of volatility of the underlying index. Take, for example, an index that begins at 100 and a 2X fund based on that index that also starts at 100. In a first trading period (for example, a day), the index rises 10% to 110. The 2X fund will then rise 20% to 120. The index then drops back to 100 (a drop of 9.09%), so that it is now even. The drop in the 2X fund will be 18.18% (2*9.09). But 18.18% of 120 is 21.82. This puts the value of the 2X fund at 98.18. Even though the index is unchanged after two trading periods, an investor in the 2X fund would have lost 1.82%. This decline in value can be even greater for inverse funds (leveraged funds with negative multipliers such as -1, -2, or -3). It always occurs when the change in value of the underlying index changes direction. And the decay in value increases with volatility of the underlying index. The effect of leverage is also reflected in the pricing of options written on leveraged ETFs. In particular, the terminal payoff of a leveraged ETF European/American put or call depends on the realized variance (hence the path) of the underlying index. The impact of leverage ratio can also be observed from the implied volatility surfaces of leveraged ETF options. For instance, the implied volatility curves of inverse leveraged ETFs (with negative multipliers such as -1, -2, or -3) are commonly observed to be increasing in strike, which is characteristically different from the implied volatility smiles or skews seen for index options or non-leveraged ETF options. In May 2017, the SEC granted approval of two 4x leveraged ETF related to
S&P 500 The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. As of ...
futures, the ForceShares Daily 4X US Market Futures Long Fund, and ForceShares Daily 4X US Market Futures Short Fund, before rescinding the approval a few weeks later. In November 2019, the SEC proposed a rule regarding the use of derivatives that would make it easier for leveraged and inverse ETFs to come to market, including eliminating a liquidity rule to cover obligations of derivatives positions, replacing it with a risk management program overseen by a derivatives risk manager. The SEC also proposed rules requiring investors to answer a series of questions before being permitted to invest in leveraged ETFs.


Thematic ETFs

Thematic ETFs typically focus on long-term, societal trends, such as disruptive technologies, climate change, or shifting consumer behaviors. Some of the most popular themes include cloud computing, robotics, and electric vehicles, as well as the gig economy, e-commerce, and clean energy. As of June 2019, 13 U.S.-listed thematic ETFs held more than US$1 billion in assets and another nine held more than US$500 million. In Canada, no Canadian-listed thematic ETF holds more than $500 million, with the fund category holding about $2.5 billion as of January 2020.


History

ETFs had their genesis in 1989 with Index Participation Shares (IPS), an
S&P 500 The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. As of ...
proxy that traded on the
American Stock Exchange NYSE American, formerly known as the American Stock Exchange (AMEX), and more recently as NYSE MKT, is an American stock exchange situated in New York City. AMEX was previously a mutual organization, owned by its members. Until 1953, it was know ...
and the Philadelphia Stock Exchange. This product was short-lived after a lawsuit by the
Chicago Mercantile Exchange The Chicago Mercantile Exchange (CME) (often called "the Chicago Merc", or "the Merc") is a global derivatives marketplace based in Chicago and located at 20 S. Wacker Drive. The CME was founded in 1898 as the Chicago Butter and Egg Board, an ...
was successful in stopping sales in the United States. The argument against the IPS approach was that it resembled a futures contract because the investments held an index, rather than holding the actual underlying stocks. In 1990, a similar product, Toronto Index Participation Shares, which tracked the TSE 35 and later the TSE 100 indices, started trading on the Toronto Stock Exchange (TSE) in 1990. The popularity of these products led the
American Stock Exchange NYSE American, formerly known as the American Stock Exchange (AMEX), and more recently as NYSE MKT, is an American stock exchange situated in New York City. AMEX was previously a mutual organization, owned by its members. Until 1953, it was know ...
to try to develop something that would satisfy regulations by the U.S. Securities and Exchange Commission. Nathan Most and Steven Bloom, under the direction of Ivers Riley, and with the assistance of Kathleen Moriarty, designed and developed
Standard & Poor's Depositary Receipts The SPDR S&P 500 trust is an exchange-traded fund which trades on the NYSE Arca under the symbol (). SPDR is an acronym for the Standard & Poor's Depositary Receipts, the former name of the ETF. It is designed to track the S&P 500 stock market i ...
(), which were introduced in January 1993. Known as SPDRs or "Spiders", the fund became the largest ETF in the world. In May 1995,
State Street Global Advisors State Street Global Advisors (SSGA) is the investment management division of State Street Corporation and the world's fourth largest asset manager, with nearly $4.14 trillion (USD) in assets under management as of 31 December 2021. The comp ...
introduced the
S&P 400 The S&P MidCap 400 Index, more commonly known as the S&P 400, is a stock market index from S&P Dow Jones Indices. The index serves as a gauge for the U.S. mid-cap equities sector and is the most widely followed mid-cap index. To be included in ...
MidCap SPDRs ().
Barclays Barclays () is a British multinational universal bank, headquartered in London, England. Barclays operates as two divisions, Barclays UK and Barclays International, supported by a service company, Barclays Execution Services. Barclays traces ...
, in conjunction with
MSCI MSCI Inc. is an American finance company headquartered in New York City. MSCI is a global provider of equity, fixed income, real estate indexes, multi-asset portfolio analysis tools, ESG and climate products. It operates the MSCI World, MSCI ...
and Funds Distributor Inc., entered the market in 1996 with World Equity Benchmark Shares (WEBS), which became iShares MSCI Index Fund Shares. WEBS originally tracked 17
MSCI MSCI Inc. is an American finance company headquartered in New York City. MSCI is a global provider of equity, fixed income, real estate indexes, multi-asset portfolio analysis tools, ESG and climate products. It operates the MSCI World, MSCI ...
country indices managed by the funds' index provider,
Morgan Stanley Morgan Stanley is an American multinational investment management and financial services company headquartered at 1585 Broadway in Midtown Manhattan, New York City. With offices in more than 41 countries and more than 75,000 employees, the fir ...
. WEBS were particularly innovative because they gave casual investors easy access to foreign markets. While SPDRs were organized as
unit investment trust In U.S. financial law, a unit investment trust (UIT) is an investment product offering a fixed (unmanaged) portfolio of securities having a definite life. Unlike open-end and closed-end investment companies, a UIT has no board of directors. A ...
s, WEBS were set up as a
mutual fund A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICA ...
, the first of their kind. In 1998,
State Street Global Advisors State Street Global Advisors (SSGA) is the investment management division of State Street Corporation and the world's fourth largest asset manager, with nearly $4.14 trillion (USD) in assets under management as of 31 December 2021. The comp ...
introduced "Sector
Spiders Spiders (order Araneae) are air-breathing arthropods that have eight legs, chelicerae with fangs generally able to inject venom, and spinnerets that extrude silk. They are the largest order of arachnids and rank seventh in total species di ...
", separate ETFs for each of the sectors of the
S&P 500 The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. As of ...
. Also in 1998, the "Dow Diamonds" () were introduced, tracking the
Dow Jones Industrial Average The Dow Jones Industrial Average (DJIA), Dow Jones, or simply the Dow (), is a stock market index of 30 prominent companies listed on stock exchanges in the United States. The DJIA is one of the oldest and most commonly followed equity inde ...
. In 1999, the influential "cubes" was launched, with the goal of replicate the price movement of the
NASDAQ-100 The Nasdaq-100 (^NDX) is a stock market index made up of 101 equity securities issued by 100 of the largest non-financial companies listed on the Nasdaq stock exchange. It is a modified capitalization-weighted index. The stocks' weights in the in ...
– originally ''QQQQ'' but later . The iShares line was launched in early 2000. By 2005, it had a 44% market share of ETF assets under management. Barclays Global Investors was sold to
BlackRock BlackRock, Inc. is an American multi-national investment company based in New York City. Founded in 1988, initially as a risk management and fixed income institutional asset manager, BlackRock is the world's largest asset manager, with trill ...
in 2009. In 2001,
The Vanguard Group The Vanguard Group, Inc. is an American registered investment advisor based in Malvern, Pennsylvania, with about $7 trillion in global assets under management, as of January 13, 2021. It is the largest provider of mutual funds and the second-l ...
entered the market by launching the Vanguard Total Stock Market ETF (), which owns every publicly traded stock in the United States. Some of Vanguard's ETFs are a share class of an existing mutual fund. iShares issued the first bond funds in July 2002: iShares IBoxx $ Invest Grade Corp Bond Fund (), which owns
corporate bond A corporate bond is a bond issued by a corporation in order to raise financing for a variety of reasons such as to ongoing operations, M&A, or to expand business. The term is usually applied to longer-term debt instruments, with maturity of ...
s, and a TIPS fund. In 2007, iShares introduced an ETF that owns high-yield debt and an ETF that owns
municipal bond A municipal bond, commonly known as a muni, is a bond issued by state or local governments, or entities they create such as authorities and special districts. In the United States, interest income received by holders of municipal bonds is often, ...
s and
State Street Global Advisors State Street Global Advisors (SSGA) is the investment management division of State Street Corporation and the world's fourth largest asset manager, with nearly $4.14 trillion (USD) in assets under management as of 31 December 2021. The comp ...
and
The Vanguard Group The Vanguard Group, Inc. is an American registered investment advisor based in Malvern, Pennsylvania, with about $7 trillion in global assets under management, as of January 13, 2021. It is the largest provider of mutual funds and the second-l ...
also issued bond ETFs. In December 2005, Rydex (now
Invesco Invesco Ltd. is an American independent investment management company that is headquartered in Atlanta, Georgia, with additional branch offices in 20 countries. Its common stock is a constituent of the S&P 500 and trades on the New York stock exc ...
) launched the first currency ETF, the Euro Currency Trust (), which tracked the value of the
Euro The euro ( symbol: €; code: EUR) is the official currency of 19 out of the member states of the European Union (EU). This group of states is known as the eurozone or, officially, the euro area, and includes about 340 million citizens . ...
. In 2007,
Deutsche Bank Deutsche Bank AG (), sometimes referred to simply as Deutsche, is a German multinational investment bank and financial services company headquartered in Frankfurt, Germany, and dual-listed on the Frankfurt Stock Exchange and the New York St ...
's db x-trackers launched the EONIA Total Return Index ETF in Frankfurt tracking the
Euro The euro ( symbol: €; code: EUR) is the official currency of 19 out of the member states of the European Union (EU). This group of states is known as the eurozone or, officially, the euro area, and includes about 340 million citizens . ...
. In 2008, it launched the Sterling Money Market ETF () and US Dollar Money Market ETF () in London. In November 2009,
ETF Securities ETF Securities is an asset management firm that issues exchange-traded funds (ETFs) primarily in Australia. History The company was founded by Australian businessman and philanthropist Graham Tuckwell. The company worked with the World Gol ...
launched the world's largest FX platform tracking the MSFXSM Index covering 18 long or short USD ETC vs. single G10 currencies. The first leveraged ETF was issued by ProShares in 2006. In 2008, the SEC authorized the creation of ETFs that use
active management Active management (also called ''active investing'') is an approach to investing. In an actively managed portfolio of investments, the investor selects the investments that make up the portfolio. Active management is often compared to passive ma ...
strategies.
Bear Stearns The Bear Stearns Companies, Inc. was a New York-based global investment bank, securities trading and brokerage firm that failed in 2008 as part of the global financial crisis and recession, and was subsequently sold to JPMorgan Chase. The com ...
launched the first actively managed ETF, the Current Yield ETF (), which began trading on the
American Stock Exchange NYSE American, formerly known as the American Stock Exchange (AMEX), and more recently as NYSE MKT, is an American stock exchange situated in New York City. AMEX was previously a mutual organization, owned by its members. Until 1953, it was know ...
on March 25, 2008. In December 2014, assets under management by U.S. ETFs reached $2 trillion. By November 2019, assets under management by U.S. ETFs reached $4 trillion. Assets under management by U.S. ETFs grew to $5.5 trillion by January 2021.


Gold

The first gold exchange-traded product was Central Fund of Canada, a
closed-end fund A closed-end fund (CEF) is a fund that raises capital by issuing a fixed number of shares which are not redeemable, and then invest that capital in financial assets such as stocks and bonds. Unlike open-end funds, new shares in a closed-end fund ...
founded in 1961. It amended its articles of incorporation in 1983 to provide investors with a product for ownership of gold and silver bullion. It has been listed on the Toronto Stock Exchange since 1966 and the
American Stock Exchange NYSE American, formerly known as the American Stock Exchange (AMEX), and more recently as NYSE MKT, is an American stock exchange situated in New York City. AMEX was previously a mutual organization, owned by its members. Until 1953, it was know ...
since 1986. The idea of a gold ETF was first conceptualized by Benchmark Asset Management Company Private Ltd in
India India, officially the Republic of India (Hindi: ), is a country in South Asia. It is the List of countries and dependencies by area, seventh-largest country by area, the List of countries and dependencies by population, second-most populous ...
, which filed a proposal with the
Securities and Exchange Board of India The Securities and Exchange Board of India (SEBI) is the Regulatory agency, regulatory body for securities and commodity market in India under the ownership of Ministry of Finance (India), Ministry of Finance within the Government of India. It w ...
in May 2002. In March 2007 after delays in obtaining regulatory approval. The first gold exchange-traded fund was Gold Bullion Securities launched on the ASX in 2003, and the first silver exchange-traded fund was iShares Silver Trust launched on the NYSE in 2006. SPDR Gold Shares, a commodity ETF, is in the top 10 largest ETFs by assets under management.


Arbitrage

Unlike mutual funds, ETFs do not sell or redeem their individual shares at net asset value. Instead, financial institutions purchase and redeem ETF shares directly from the ETF, but only in large blocks (such as 50,000 shares), called creation units. Purchases and redemptions of the creation units generally are in kind, with the institutional investor contributing or receiving a basket of Security (finance), securities of the same type and proportion held by the ETF, although some ETFs may require or permit a purchasing or redeeming shareholder to substitute cash for some or all of the securities in the basket of assets. The ability to purchase and redeem creation units gives ETFs an
arbitrage In economics and finance, arbitrage (, ) is the practice of taking advantage of a difference in prices in two or more markets; striking a combination of matching deals to capitalise on the difference, the profit being the difference between t ...
mechanism intended to minimize the potential deviation between the market price and the net asset value of ETF shares. ETFs generally have transparent Portfolio (finance), portfolios, so institutional investors know exactly what portfolio assets they must assemble if they wish to purchase a creation unit, and the exchange disseminates the updated net asset value of the shares throughout the trading day, typically at 15-second intervals. ETF distributors only buy or sell ETFs directly from or to authorized participants, which are large broker-dealers with whom they have entered into agreements—and then, only in creation units, which are large blocks of tens of thousands of ETF shares, usually exchanged in-kind with Basket (finance), baskets of the underlying security (finance), securities. Authorized participants may wish to invest in the ETF shares for the long term, but they usually act as market makers on the open market, using their ability to exchange creation units with their underlying securities to provide market liquidity of the ETF shares and help ensure that their intraday market price approximates the net asset value of the underlying assets. Other investors, such as individuals using a retail broker, trade ETF shares on this
secondary market The secondary market, also called the aftermarket and follow on public offering, is the financial market in which previously issued financial instruments such as stock, bonds, options, and futures are bought and sold. The initial sale of the ...
. If there is strong investor demand for an ETF, its share price will temporarily rise above its net asset value per share, giving arbitrageurs an incentive to purchase additional creation units from the ETF and sell the component ETF shares in the open market. The additional supply of ETF shares reduces the market price per share, generally eliminating the wikt:premium, premium over net asset value. A similar process applies when there is weak demand for an ETF: its shares trade at a discount from net asset value. When new shares of an ETF are created due to increased demand, this is referred to as ETF inflows. When ETF shares are converted into the component securities, this is referred to as ETF outflows. ETFs are dependent on the efficacy of the arbitrage mechanism in order for their share price to track net asset value.


Risks


Tracking error

The ETF tracking error is the difference between the returns of the ETF and its reference index or asset. A non-zero tracking error therefore represents a failure to replicate the reference as stated in the ETF prospectus. The tracking error is computed based on the prevailing price of the ETF and its reference. It is different from the premium/discount which is the difference between the ETF's NAV (updated only once a day) and its market price. Tracking errors are more significant when the ETF provider uses strategies other than full replication of the underlying index. Some of the most liquid equity ETFs tend to have better tracking performance because the underlying index is also sufficiently liquid, allowing for full replication. In contrast, some ETFs, such as commodities ETFs and their leveraged ETFs, do not necessarily employ full replication because the physical assets cannot be stored easily or used to create a leveraged exposure, or the reference asset or index is illiquid. Futures-based ETFs may also suffer from negative roll yields, as seen in the VIX futures market. While tracking errors are generally non-existent for the most popular ETFs, they have existed during periods of market turbulence such as in late 2008 and 2009 and during flash crashes, particularly for ETFs that invest in foreign or emerging-market stocks, future-contracts based commodity indices, and high-yield debt. In November 2008, during a period of market turbulence, some lightly traded ETFs frequently had deviations of 5% or more, exceeding 10% in a handful of cases, although even for these niche ETFs, the average deviation was only a little more than 1%. The trades with the greatest deviations tended to be made immediately after the market opened. Per
Morgan Stanley Morgan Stanley is an American multinational investment management and financial services company headquartered at 1585 Broadway in Midtown Manhattan, New York City. With offices in more than 41 countries and more than 75,000 employees, the fir ...
, in 2009, ETFs missed their targets by an average of 1.25 percentage points, a gap more than twice as wide as the 0.52-percentage-point average they posted in 2008.


Liquidity risk

ETFs have a wide range of liquidity. The most popular ETFs (such as those tracking the
S&P 500 The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. As of ...
) are constantly traded, with tens of millions of shares per day changing hands, while others trade in much lower numbers. There are many ETFs that do not trade very often, and thus might be difficult to sell compared to more liquid ETFs. The most active ETFs are ''very'' liquid, with high regular trading volume and tight bid-ask spreads (the gap between buyer and seller's prices), and the price thus fluctuates throughout the day. This is in contrast with mutual funds, where all purchases or sales on a given day are executed at the same price at the end of the trading day. New regulations to force ETFs to be able to manage systemic stresses were put in place following the 2010 flash crash, when prices of ETFs and other stocks and options became volatile, with trading markets spiking and bids falling as low as a penny a share in what the
Commodity Futures Trading Commission The Commodity Futures Trading Commission (CFTC) is an independent agency of the US government created in 1974 that regulates the U.S. derivatives markets, which includes futures, swaps, and certain kinds of options. The Commodity Exchange Act ...
(CFTC) investigation described as one of the most turbulent periods in the history of financial markets. These regulations proved to be inadequate to protect investors in the August 24, 2015, flash crash, "when the price of many ETFs appeared to come unhinged from their underlying value." ETFs were consequently put under even greater scrutiny by regulators and investors. Analysts at Morningstar, Inc. claimed in December 2015 that "ETFs are a 'digital-age technology' governed by 'Depression-era legislation".


Risks of synthetic ETFs

Synthetic ETFs, which do not own securities but track indexes using derivatives and swaps, have raised concern due to lack of transparency in products and increasing complexity; conflicts of interest; and lack of regulatory compliance.


Counterparty risk

A synthetic ETF has counterparty risk, because the counterparty is contractually obligated to match the return on the index. The deal is arranged with collateral posted by the swap counterparty. A potential hazard is that the investment bank offering the ETF might post its own collateral, and that collateral could be of dubious quality. Furthermore, the investment bank could use its own trading desk as counterparty. These types of set-ups are not allowed under the European guidelines, Undertakings for Collective Investment in Transferable Securities Directive 2009 (UCITS). Counterparty risk is also present where the ETF engages in securities lending or total return swaps.


Effects on price stability

Purchases and sales of commodities by ETFs can significantly affect the price of such commodities. Per the International Monetary Fund, "Some market participants believe the growing popularity of exchange-traded funds (ETFs) may have contributed to equity price appreciation in some emerging economies, and warn that leverage embedded in ETFs could pose financial stability risks if equity prices were to decline for a protracted period." Some critics claim that ETFs can be, and have been, used to manipulate market prices, such as in conjunction with short selling that contributed to the United States bear market of 2007–2009.


Perception and adoption of ETFs in the European market

The first European ETF came on the market in 2000 and the European ETF market has seen tremendous growth since. At the end of March 2019, the asset under management in the European industry stood at €760bn, compared with an amount of €100bn at the end of 2008. The market share of ETFs has increased significantly in recent years. At the end of March 2019, ETFs account for 8.6% of total AUM in investment funds in Europe, up from 5.5% five years earlier. The use of ETFs has also evolved over time, as shown by regular observations of investment professionals’ practices in Europe. EDHEC surveys show an increasing propagation of ETF adoption over the years, especially for traditional asset classes. While ETFs are now used across a wide spectrum of asset classes, in 2019 the main use is currently in the area of equities and sectors, for 91% (45% in 2006) and 83% of the survey respondents, respectively. This is likely to be linked to the popularity of indexing in these asset classes, as well as to the fact that equity indices and sector indices are based on highly liquid instruments, which makes it straightforward to create ETFs on such underlying securities. The other asset classes for which a large share of investors declare using ETFs are commodities and corporate bonds (68% for them both, to be compared with 6% and 15% in 2006, respectively), smart beta-factor investing and government bonds (66% for them both, to be compared with 13% for government bonds in 2006). Investors have a high rate of satisfaction with ETFs, especially for traditional asset classes. In 2019, we observe 95% satisfaction for both equities and government bond asset.


The role of ETFs in the asset allocation process

Over the years, EDHEC survey results have consistently indicated that ETFs were used as part of a truly passive investment approach, mainly for long-term buy-and-hold investment, rather than tactical allocation. However, over the past three years, the two approaches have gradually become more balanced and, in 2019, European investment professionals declare that their use of ETFs for tactical allocation is actually greater than for long term positions (53% and 51% respectively). ETFs, which originally replicated broad market indices, are now available in a wide variety of asset classes and a multitude of market sub-segments (sectors, styles, etc.) If gaining broad market exposure remains the main focus of ETFs for 73% of users in 2019, 52% of respondents declare using ETFs to obtain specific sub-segment exposure. The diversity of ETFs increases the possibilities of using ETFs for tactical allocation. Investors can easily increase or decrease their portfolio exposure to a specific style, sector, or factor at lower cost with ETFs. The more volatile the markets are, the more interesting it is to use low cost instruments for tactical allocation, especially that cost is a major criterion for selecting an ETF provider for 88% of respondents.


Expectations for ETF future developments in Europe

Despite a high current adoption rate of ETFs and the already high maturity of this market, a high percentage of investors (46%) still plan to increase their use of ETFs in the future, according to the EDHEC 2019 survey responses. Investors are planning to increase their ETF allocation to replace active managers (71% of respondents in 2019), but are also seeking to replace other passive investing products through ETFs (42% of respondents in 2019). Lowering costs is the main motivation for increasing the use of ETFs for 74% of investors. Investors are especially demanding for further developments of ETF products in the area of Ethical/SRI and smart beta equity / factor indices. In 2018, ESG ETFs enjoyed growth of 50%, reaching €9.95bn, with the launch of 36 new products, against just 15 in 2017. However, 31% of the EDHEC 2019 survey respondents still require additional ETF products based on sustainable investment, which appears to be their top concern. Investors are also demanding for ETFs related to advanced forms of equity indices, namely those based on multi-factor and smart beta indices (30% and 28% of respondents, respectively), and 45% of respondents would like to see further developments in at least one category related to smart beta equity or factor indices (smart beta indices, single-factor indices and multi-factor indices). Consistent with the desire to use ETFs for passive exposure to broad market indices, only 19% of respondents show any interest in future development of actively managed equity ETFs.


Notable issuers of ETFs

* AdvisorShares: issues actively managed ETFs only, majority owned by Fund.com * Ark Invest, ARK Investment Management: issues actively managed ETFs that invest in companies involved in disruptive innovation * Banco Itau: issues ETFs in Brazil * BetaShares: issues ETFs in Australia * Bips Investment Managers: issues Bips (Beta Investment Performance Securities) in South Africa *
BlackRock BlackRock, Inc. is an American multi-national investment company based in New York City. Founded in 1988, initially as a risk management and fixed income institutional asset manager, BlackRock is the world's largest asset manager, with trill ...
: issues iShares * BNP Paribas: issues EasyETFs in Europe * Boost ETP: issues short (inverse) and leveraged exchange-traded products including 3X equity and commodity products in Europe * Charles Schwab Corporation: issues ETFs *
Deutsche Bank Deutsche Bank AG (), sometimes referred to simply as Deutsche, is a German multinational investment bank and financial services company headquartered in Frankfurt, Germany, and dual-listed on the Frankfurt Stock Exchange and the New York St ...
: issues Xtrackers ETFs, and manages PowerShares DB commodity- and currency-based ETFs *
ETF Securities ETF Securities is an asset management firm that issues exchange-traded funds (ETFs) primarily in Australia. History The company was founded by Australian businessman and philanthropist Graham Tuckwell. The company worked with the World Gol ...
: issues ETFs primarily in Australia * Franklin Templeton Investments: Issues LibertyShares® ETFs * Global X Funds: issues ETFs * Guggenheim Partners: issues specialty Guggenheim Funds ETFs * Indo Premier Investment Management: issues Premier ETFs in Indonesia Stock Exchange *
Invesco Invesco Ltd. is an American independent investment management company that is headquartered in Atlanta, Georgia, with additional branch offices in 20 countries. Its common stock is a constituent of the S&P 500 and trades on the New York stock exc ...
: issues Invesco PowerShares, Invesco ETFs, as well as BLDRS based on American depositary receipts * KraneShares: issues China and climate focused ETFs * Lyxor Asset Management: issues Lyxor ETFs in France * Natixis Investment Managers: issues Active International Minimum Volatility ETF (MVIN) and Active Short Duration Income ETF (LSST) * NextFins: issues Nifty India Financials ETF (INDF) * Standard Life Aberdeen: issues commodity ETFs *
State Street Global Advisors State Street Global Advisors (SSGA) is the investment management division of State Street Corporation and the world's fourth largest asset manager, with nearly $4.14 trillion (USD) in assets under management as of 31 December 2021. The comp ...
: issues SPDRs *
The Vanguard Group The Vanguard Group, Inc. is an American registered investment advisor based in Malvern, Pennsylvania, with about $7 trillion in global assets under management, as of January 13, 2021. It is the largest provider of mutual funds and the second-l ...
: issues Vanguard ETFs, formerly known as VIPERs * United States Commodity Funds: issues commodity ETFs such as the
United States Oil Fund The United States Oil Fund () is an exchange-traded fund (ETF) that attempts to track the price of West Texas Intermediate Light Sweet Crude Oil. It is distinguished from an exchange-traded note (ETN) since it represents an ownership claim on u ...
* Van Eck Global: issues Market Vectors ETFs * WisdomTree Investments: issues specialty ETFs


See also

* Exchange for ETF (EFETF) – a method in which market makers exchange their ETFs for futures contracts. *
Exchange-traded note An exchange-traded product (ETP) is a regularly priced security which trades during the day on a national stock exchange. ETPs may embed derivatives but it is not a requirement that they do so - and the investment memorandum (or offering documents ...
(ETN)


References


Further reading

* Carrell, Lawrence. ''ETFs for the Long Run: What They Are, How They Work, and Simple Strategies for Successful Long-Term Investing''. Wiley (publisher), Wiley, September 9, 2008. * Ferri, Richard A. ''The ETF Book: All You Need to Know About Exchange-Traded Funds''. Wiley (publisher), Wiley, January 4, 2011. * Humphries, William. ''Leveraged ETFs: The Trojan Horse Has Passed the Margin-Rule Gates''. 34 Seattle U.L. Rev. 299 (August 31, 2010), available a
Seattle University Law Review
* Koesterich, Russ. ''The ETF Strategist: Balancing Risk and Reward for Superior Returns''. Penguin Books, May 29, 2008. * Lemke, Thomas P.; Lins, Gerald T. & McGuire, W. John. ''Regulation of Exchange-Traded Funds''. LexisNexis, 2015.


External links


A brief history of ETFs
– Trackinsight
Exchange Traded Funds (ETF)
– Australian Stock Exchange (ASX)
Exchange Traded Funds (ETF)
– Johannesburg Stock Exchange (JSE)
Exchange Traded Funds (ETF)
– London Stock Exchange (LSE)
Exchange Traded Funds (ETF)
Toronto Stock Exchange (TSX)
Exchange Traded Products
– New York Stock Exchange
Funds + ETFs
– NASDAQ Stock Market
The ETF Hall of Fame: 25 People Who Revolutionized the ETF Industry
– ETF Database
What are ETFs?
– Trackinsight {{Investment-management Exchange-traded funds,