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The legal structure and makeup varies around the world, however the major common features include:
These qualities provide ETFs with some significant advantages compared with traditional Open-ended Collective Investments . The ETF structure allows for a diversified, low cost, low turnover index investment. This appeals to both institutional and retail investors both for long term holding and for selling short and hedging strategies. INDEX BASIS Many current U.S. ETFs are based on some index; for example, SPDRs (Standard & Poor's Depository Receipts, or "Spiders") () are based on the S&P 500 index. The index is generally determined by an independent company; for example, Spiders are run by State Street , while the S&P 500 is calculated by Standard & Poor's . Sometimes, a proprietary index is used. Although the SEC states that an ETF is "a type of investment company whose investment objective is to achieve the same return as a particular market index," this is no longer reality. The development of investment structures has progressed more quickly than the SEC's website. A series of ETFs introduced by ProShares in 2006 - 2007 no longer follow the traditional definition. These funds, while correlating to the performance of the S&P 500, NASDAQ 100, DJIA, and S&P 400 Midcap, do not attempt to merely achieve the same return as the underlying index. These forty funds attempt to either achieve the daily performance of the designated benchmark times two, times negative one, or times negative two. They are ETFs with integrated leverage. Another example of an innovative ETF that has broken the classic mold is the oil futures ETF: USO. This ETF tracks the performance of the Western Texas Intermediate light sweet crude. This is not a benchmark, but a traded commodity. Rydex has taken a different direction and worked with S&P to create new, equal-weight benchmarks for their proprietary benchmarks. These "benchmarks" are rebalanced quarterly. CREATION AND REDEMPTION OF SHARES Rather than the fund manager dealing directly with shareholders, parties who have entered into a contract with the fund, such as Institutional Investor s, and called Authorized Participants (APs) will create a basket of shares replicating or approximating the index, and deliver them to the fund in exchange for ETF shares. A basket, or ''creation unit'', consists of anywhere from 10,000 ETF shares to 600,000 ETF shares. ETF shares are then sold and resold freely among investors on the open market. If an investor accumulates a sufficient amount of ETF shares, he can exchange one full creation unit of ETF shares for a basket of the underlying shares of stock. The ETF creation unit is then redeemed and the underlying stocks are delivered out of the fund. One of the advantages of this creation / redemption method for the fund investors is that institutional investors cover the dealing costs in purchasing the required shares to make up the portfolio. One of the reasons they are willing to do this is that they can profit by Arbitrage based on the trading price of shares on the secondary market. Shares will trade at a premium to net asset value if demand is high and at a discount to net asset value if demand is low. These market drivers provide the efficiency for the ETF managers as the bulk buying power of the institutional investors allows them to avoid the expense of mass share creation and deletion. ACTIVELY MANAGED ETF People have talked about 'actively managed ETF' for a long time, based somewhat on analogy with Mutual Fund s. Others feel that such a thing is contradictory and nonsensical. Some have sought to bring the much older (and normally actively managed) Investment Trust class of fund under the ETF umbrella, pointing out the fact that these are also funds that trade on exchanges. Real Estate Investment Trust units also commonly trade on exchanges and have properties similar to an ETF. ETFs are mainly exchanged 'in-kind'; holdings of ETFs are made available daily. This is felt to be a strength since no one knows more than anyone else about what the fund holds. If holdings were secret, it would be difficult to buy an ETF, since one would not know what shares to transfer; similarly, if one sells and gets the component shares, the holdings would not be secret. This seems to cause problems for an actively managed fund. Similarly, Arbitrageur s are less likely to bid aggressively if they don't know what they are buying and selling. All of this is in contrast to mutual funds, which are allowed to keep holdings unknown for many months. Lastly, some people think that owners of ETFs are more sophisticated, therefore more likely to be proponents of indexing (a passive strategy). So it is not immediately obvious who would buy actively managed ETFs. USAGE Today ETFs present a viable alternative investment option to traditional open-ended mutual funds, especially open-ended Index Fund s. There are many available ETFs that attempt to track all kind of indexes (such as large-cap, mid-cap, small-cap, etc), fixed income, style (such as value and growth), industries, countries, precious metals and other commodities and more are being developed. ETFs also enable people living outside the United States to participate in US based mutual funds. Traditional open-ended US mutual funds are available only to US residents, whereas anyone in the world can purchase shares in an ETF that trades on the open market. HISTORY The first ETF was introduced on the Toronto Stock Exchange in 1990. There are over one hundred ETFs traded on the American Stock Exchange , with more in other countries. ETFs have been gaining popularity ever since they were introduced on the American Stock Exchange in the mid 1990s , beginning with SPY (launched by State Street Global Advisors and tracking the S&P 500) in 1993. ETFs are attractive to investors because they offer the diversification of mutual funds with the features of a stock. The popularity of these funds is likely to increase as new and more innovative ETFs are introduced. The original ETFs were set up as competitors to open-ended index funds, and subsequent ETFs have usually followed in their footsteps: they typically have very low Expense Ratio s compared to actively managed mutual funds. They also have a lower Turnover Ratio , which in some jurisdictions can be more Tax-favorable . ETF managers such as BGI and State Street Global Advisors are the current leaders in the ETF industry by assets under management, with 75% of the market. ETFS VS. OPEN-ENDED FUNDS Given that ETFs trade on an exchange, each transaction is subject to the broker's fee. Many mutual funds do not charge such fees. In scenarios where an investor transacts frequently, or for small amounts, these fees for trading ETFs can erode gains and thus make investing in a mutual fund more attractive. However, with the advent of low or no-cost transactions from various brokerages, this advantage of mutual funds over ETFs has been diminished in many cases. ETF fees also tend to be slightly more transparent than fees for mutual funds. There are no deferred sales charges, or other kickbacks to the dealer. Instead there is a regular MER, and the initial exchange commission, if any, to purchase the ETF. There are many advantages to ETFs, and these advantages will likely increase over time. Most ETFs have a lower Expense Ratio than comparable mutual funds. Mutual funds can charge 1% to 3%, or more; index funds are generally lower, while ETFs are almost always in the 0.1% to 1% range. Over the long term, these cost differences can compound into a noticeable difference. ETFs are more that is not balanced by a realized loss, the mutual fund must distribute the capital gains to their shareholders by the end of the quarter. This can happen when stocks are added to and removed from the index, or when a large number of shares are redeemed (such as during a panic). These gains are taxable to all shareholders, even those who reinvest the gains distributions in more shares of the fund. In contrast, ETFs are not redeemed by holders (instead, holders simply sell their ETF on the stock market, as they would a stock), so that investors generally only realize capital gains when they sell their own shares. However, there are some potential taxation drawbacks to ETFs in the United States. One argument made in favor of index mutual funds having a tax advantage over ETFs is that ETFs often trade their shares more rapidly to maintain a high cost basis of their underlying shares. This can result in ETF dividends failing to be classified as qualified dividends since the underlying shares don’t satisfy the IRS requirements. This can be a substantial drawback since your ordinary tax rate may be significantly higher than the 15% tax charged on qualified dividends. Perhaps the most important, although subtle, benefit of an ETF is the stock-like features offered. Since ETFs trade on the market, investors can carry out the same types of trades that they can with a stock. For instance, investors can Sell Short , use a Limit Order , use a Stop-loss Order , Buy On Margin , and invest as much or as little money as they wish (there is no minimum investment requirement). Also, many ETFs have the capability for Options ( Puts and Calls ) to be written against them. Mutual funds do not offer those features. For example, an investor in an open-ended fund can only purchase or sell at the end of the day at the mutual fund's closing price. This makes stop-loss orders much less useful for open-ended funds – if your broker even allows them. An ETF is continually priced throughout the day and therefore is not subject to this disadvantage, allowing the user to react to adverse or beneficial market condition on an intraday basis. This stock-like Liquidity allows an investor to trade the ETF for cash throughout regular trading hours, and often after-hours on ECNs . ETF liquidity varies according to trading volume and liquidity of the underlying securities, but very liquid ETFs such as SPY, DIA, and QQQQ can be traded pre-market and after-hours with reasonably tight Spreads . These characteristics can be important for investors concerned with Liquidity Risk . A more subtle advantage is that ETFs, like closed-ended funds, are immune from some market timing problems that have plagued open-ended mutual funds. In these timing attacks, large investors trade in and out of an open ended fund quickly, exploiting minor variances in price in order to profit at the expense of the long-term unit holders. With an ETF (or closed-ended fund) such an operation is not possible--the underlying assets of the fund are not affected by its trading on the market. MAJOR ISSUERS OF ETFS
TOP U.S. ETFS The first, and most widely held (as of 2007) US ETF is the Standard & Poor's Depository Receipt , abbreviated SPDR. Shares of SPDR, called "spiders", are issued by State Street Global Advisors, and listed on the American Stock Exchange under the ticker SPY. Also popular and well known are the ETFs that track the NASDAQ-100 index ("qubes") and the Dow Jones Industrial Average DIA ("diamonds"), also issued by State Street Global Advisors. Top 10 US -based ETFs, by assets under management (April 2007):
EUROPEAN ETFS In the European Union many ETFs are traded as cross border UCITS III funds. For example the UK iShares are Irish registered UCITS funds and trade on the London Stock Exchange . Other ETF's are offered by Indexchange Investments AG , whose funds are listed in Germany on the Deutsche Börse . Indexchange was a subsidiary of HypoVereinsbank . It has been acquired by Barclays Global Investors {Link without Title}
SWEDISH ETFS In Sweden six ETFs exist as of November 2006, all provided by XACT Fonder :
FINNISH ETFS
CANADIAN ETFS In Canada, Barclays Global Investors is the largest ETF provider, offering ETFs under the iShares brand name:
Claymore Investments also offers a series of ETFs available in Canada:
Horizons Betapro also offers a series of ETFs available in Canada:
HONG KONG ETFS
TOP REPUBLIC OF KOREA ETFS All ROK -based ETFs, as of June 2006:
JAPAN ETFS
COMMODITY ETFS Commodity ETFs, also known as exchange-traded commodities (ETCs), track a specific commodity or a general commodity index, such as:
Since September 2006, numerous ETFs have been available on the London Stock Exchange {Link without Title} . ETCs invest in real commodities (via future contracts or storing gold bars, for example) and not in commodity producing companies, such as mining companies, though of course, mining-company ETFs also exist. SEE ALSO
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