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Features of Exchange Traded Funds - ETF

    IndianMoney.com Research Team | Thursday, April 30,2009, 04:13 PM
 

The enormous majority of ETFs are calculated to track an index so their presentation is close to that of an index mutual fund but they are not exact duplicates. A tracking error or the dissimilarity between the returns of a fund and the profits of the index can occur due to differences in composition management fees, expenses and handling of dividends. Following are the important features of ETFs.

Buying and Selling ETFs Can Be Good for the Small Investor

ETFs enjoy continuous pricing they can be purchased and sold on a stock exchange all through the trading day. Since ETFs trade like stocks you can place orders just like with individual stocks - such as limit orders, good-until-canceled orders and stop loss orders etc. They can also be sell short. Traditional mutual funds are bought and redeemed based on their net asset values (NAV) at the end of the day. ETFs are bought and sold at the market prices on the exchanges which resemble the underlying NAV but are independent of it. However arbitrageurs will guarantee that ETF price are kept very close to the NAV of the fundamental securities.

Even though an investor can buy as many as one share of an ETF but most buy in board lots. Anything bought in less than a board lot will increase the cost to the investor. Anyone can buy any ETF no matter where in the world it trades. These provide a benefit over mutual funds which usually can only be bought in the country in which they are registered.

Treatment of Dividends

An ETF naturally pays out dividends recognized from the underlying stocks on a periodical basis. However the fundamental stocks pay dividends all through the quarter. Therefore these funds can hold cash for a range of time periods all through the quarter even though the underlying benchmark index is not collected of cash. With dividend-paying ETFs the cash ends up in your brokerage account instead just like the dividend on a standard stock. If you want to reinvest that cash you have to make another purchase.

Tax Efficiency

Index ETFs are passively managed portfolios they tend to offer superior tax profit than regular mutual funds. They produce fewer capital gains due to low turnover of the securities and realize fewer capital gains than actively managed funds. An index ETFs only sells securities to replicate changes in its underlying index. Traditional mutual funds accrue these unrealized capital gains liabilities as the portfolio's stocks raise in value. When the fund sells those stocks it distributes the capital gains to its investors in quantity to their ownership. This selling results in greater taxes for mutual fund owners.

Transparency

As said the ETFs are considered to duplicate the performance of their underlying index or commodity. Investors for all time know exactly what they are buying and can see exactly what constitutes the ETF. The fees are also obviously laid out. Because mutual funds only have to report their holdings twice a year when you buy into a mutual fund what you're getting may not be as clear.

Fees and Commissions

One of the main features of ETFs is their low annual fee especially when compared to traditional mutual funds. The inactive nature of index investing, reduced marketing, and distribution and accounting expenses all donate to the lower fees. However individual investors must pay a brokerage commission to purchase and sell ETF shares, for those investors who trade regularly, this can considerably increase the cost of investing in ETFs. That said with the arrival of low-cost brokerage fees small or frequent purchases of ETFs are becoming more cost efficient.

Options

A number of ETFs have options that can be traded. They can be used to generate different investment strategy in coincidence with the underlying ETF. This allows ETF investors to make use of leverage in their portfolios.

IndianMoney.com Research Team

The research team at IndianMoney.com comprises of certified and experienced professionals who share the company's vision to make every Indian financially literate by equipping every Indian with right and unbiased advice. IndianMoney.com research team provides newsletters, articles, videos and FAQs on various financial products and concepts only to help you make wise financial decisions.

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