ETF, short form for Exchange Traded Funds, is a type of collective security format for other securities like stocks, which tracks an underlying index or uses various strategies. They can also be called as index funds that are traded on exchanges like the stock exchange. Although they’re similar to that of mutual funds, they still involve trades throughout the day like any other ordinary stocks—example SPDR S&P 500 ETF that tracks the S&P 500 Index.
ETF is called as an Exchange Traded Fund because it is traded on exchanges like the stocks. Since the shares of the ETF’s are bought and sold on the market, they keep changing throughout the day, which is entirely opposite to the mutual funds as they’re not traded often in a day. Mutual funds are traded just once in a day when the trade market closes. Hence when we compare the two, it is evident that ETF’s are more liquid and reliable than the Mutual funds.
They are famous for operating in an arbitrary mechanism, which means their trading is close to the net asset values, despite occasional deviations. The ETF shares are sold only through the authorized participants, that are generally larger brokers or dealers with whom they enter into agreements. And the shares are sold usually in more significant numbers like ten or thousands of stocks.
There are various types of ETF’s
- Bond ETF: They include government, state, local and municipal bonds
- Industry ETF: They are invested in one particular technology, or banking sector, gas sector etc.
- Commodity ETFs: they invest in commodities like gold or crude oil.
- Currency ETFs:They invest in foreign currencies like dollars and Euros.
- Inverse ETFs: They’re based on earning gains from stock declines by selling and repurchasing stock at a much lower price.
How to buy and see
The buying and selling of ETFs happen through online platforms or traditional brokers and dealers. Some of them are dedicated to tracking an index of all the stocks and to create a portfolio, or sometimes they even target various industries. For example, the oldest and the most thriving ETF is the SPDR S&P 500, that tracks the S&P 500 Index as well.
Pros of using ETFs
- It provides access to sticks across various industries
- It provides lower expense and reduces the broker commissions
- Enhances the risk management factors through diversification
- ETFs that focuses on the targeted industries thrive well In the market
Cons of using ETFs
- It is high Maintenance with higher fees
- Single industry often limit their ETF limits
- The liquidity provided is low, and hence it hinders all transactions
ETF Creation and Redemption
The process of supply of ETF shares is done in two different mechanisms called creation and redemption, involving special investors called Authorized Participants
Creation: Creation happens when the AP buys shares from the index, which is tracked by the fund and shares them to the ETF for newer ETF shares at a reasonable or equal value.
Redemption: It happens contrary to the creation where the AP buys stocks of the open market and sells them to the ETF Sponsor.