The Plot of ETFs
Exchange-Traded Funds (ETFs) hold a basket of assets, equities, commodities, or bonds just like a mutual fund but trade much like a stock on the exchanges. They are created and managed by the biggest asset managers in the world, together commanding over $5 Trillion in assets.
For instance, the ETF manager (known as the Sponsor) Blackrock, after careful consideration decides to offer the index-based ETF iShares Core S&P 500 (note, it is not necessary for an ETF to be index-based). After finalising this concept and obtaining approval from SEC, Blackrock brings together authorized participants, usually market makers, brokers, or large institutional investors like Goldman Sachs, that pool together the required securities into a trust. This trust is used to make the ETF’s creation units (think, stocks or shares) and are given back to the authorised participants for sale on to the open market – NYSE, NASDAQ, NYSE ARCA. These authorised participants are also responsible for ensuring adequate liquidity.
Investor Advantages
Low cost – ETFs expense ratios (cost to the investor per year for managing the ETF) is almost always < 1% and no entry or exit loads.
Because of their stocks like structure that allows intraday trading, ETFs are highly liquid providing the investor with a higher degree of protection than mutual funds in the case of adverse events. For instance, the Vanguard Real Estate trades $400 Million in daily volume and at minimal spreads of 0.01%.
Passively track indices / investment styles
Diversification and exposure to commodities and other instruments not entirely available to mutual funds.
Total transparency as opposed to mutual funds with monthly disclosures.
Caution over ETFs
An overwhelming number of ETFs have emerged, exploding to 2000+ with assets north of $5 Trillion, and they are not created equally, with some more actively managed than others. They require a nuanced selection program that varies with time and circumstance.
As opposed to popular view, the passivity of ETFs depends on the underlying index being tracked and whether it is passively managed or actively. Hence, ETFs come with a wide-variety of risk characteristics – They are not always just the market risk.
Winning with ETFs
Portfolio completion. The problem for retail investors is a lack of access to quality wealth management, and should any advice be given, the advice tends to be on a select few products (some mutual fund, or some insurance scheme) but never geared to the investor’s entire portfolio / wealth. With ETFs it is possible for the investor to manage their wealth as it should be, with the ability to gain insight on each and every component.
Understanding the element of dynamism. Given the purity of the investment style is preserved by ETFs, investors and their managers begin to understand that there is a time for certain investments. There is a time when there are debt burdens on individuals and corporations system-wide and so investments should be geared towards essential resources or tech companies with low fixed costs. There are times when global trade policies add uncertainty to investments and markets are particularly volatile, for which volatility ETFs could present opportunity to the more opportunistic investor. With such highly liquid investment vehicles investors can better manage their wealth to their own styles.
Research Sources