What is ETF (Exchange Traded Fund)?

ETFs are open-ended investment funds admitted to trading on a stock exchange and whose aim is to obtain performance dependent on the behavior of a certain benchmark, the benchmark (Neves, Fernandes & Martins, 2019)

In other words, this is a way to multiply your assets by investing in stocks. But such investments require constant monitoring. Exchange-traded funds help to do this without having the finger on the pulse. Unlike Mutual Fund (Regular Fund).

Why are ETFs relevant?

Exchange traded funds are among the fastest increasing investment products in the world. Since their introduction in 1993, they have evolved. And by the end of 2018, assets invested in ETFs increased 20 times, reaching more than $ 3.7. ETFs can be short traded just like stocks. The seller borrows the stock, sells at a high price, then buys at a lower price and gives back to the owner. That gives an opportunity to profit from the difference in prices.

Exchange traded funds are one of the cheapest ways to invest in the Swiss stock market. ETFs are a great way to preserve your investment,too. The Swiss currency has proven itself to be one of the most resistant to the Covid-19 pandemic.

Total net assets of index funds, active funds, and ETFs. This figure depicts total net assets at the year-end of active funds, index funds, and passive ETFs from 2003 until 2018. Data stem from Investment Company Institute

ETFs are open-ended investment funds admitted to trading on a stock exchange

Information is taken from Swiss Society for Financial Market Research 2020

ETF classification

ETFs can be divided into two categories: physical and synthetic. Physical ETFs contain underlying securities. For example: bonds or stocks. Synthetic ETFs use total yield swaps to replicate the price of an index. Swap is a trade and financial transaction of exchange of various assets in the form of securities (for example), supplemented by the conclusion of a counter transaction on the sale of the same goods after a certain period on the same or different conditions.

More than 80% of ETF assets are physical. Synthetic ETFs are only for money market and commodity asset classes.

Legal classification of ETFs

 

Exchange-traded open-ended index mutual investment fund

Registered in 1940 under the SEC Investment Companies Act, dividends are reinvested on the day they are received and paid to shareholders every quarter.

 

Exchange-Traded Unit Investment Trust (UIT)

Exchange-traded mutual funds are regulated by the aforementioned law. However, they must:

-Reproduce their specific indexes

– Limit investment in one issue to 25% or less

· To establish additional restrictions for sabotage and non-sabotage funds.

Dividends are not automatically reinvested, but paid quarterly

 

Exchange-Traded Grantor Trust

The investor owns the underlying shares of the company in which the ETF is invested. Includes voting rights. Dividends are not reinvested. And paid directly to shareholders.

Exchange-Traded Grantor Trust

 

https://www.sec.gov/investment/fast-answers/divisionsinvestmentinvcoreg121504htm.html

 

Briefly about ETF architecture

ETF architecture can be divided into primary and secondary.

Primary: ETF sponsor (provider, manager) and Authorized Participant (usually a market maker or large financial institution). These parties enter into an agreement that directly interacts with the financial market.

Secondary ETF Market – Selling stocks for an exchange.

 

Different From a Regular Fund and ETF

Mutual funds and exchange-traded funds have a lot in common. And they represent a common way of allocating capital for investors. However, there are basic differences between them that investors need to know.

The important difference is that ETFs can be traded like stocks, while mutual funds can only be bought at the end of each trading day at the settlement price. ETFs are collected on the basis of a specific stock exchange index, that means, they do not imply active management. How are they similar to securities?

Typically, ETFs have a lower minimum investment than index funds. Often, all that is needed to invest in an exchange-traded fund is the purchase price of one share. Sometimes you can even buy part of the stock. In contrast, index funds often have buy-in (minimum purchase amount). For example, $ 2,500, and the stock costs $ 100. That means, you need to buy 25 shares.

While buying a mutual investment fund, the net asset value (NAV) of the shares in the fund is paid. But when you buy an ETF, you pay the market value. Which way is better depends on the situation.

Mutual funds generally have higher fees and expense ratios than ETFs. Often these costs eat up a significant portion of the profit. From this we can conclude that if your priority is not annual investment income, but investments that will grow without increasing annual tax liabilities. Why are tax liabilities lower? Firstly, a smaller turnover. An Exchange Traded Fund is a good option. The ETF will grow through the distribution of capital gains. Capital Gains Distribution is the investor’s share of the fund’s proceeds from the sale of shares and other assets. Which is great for a buy and hold strategy.

ETFs, on the other hand, are passively managed portfolios, that is why, they receive less capital gains than actively managed mutual funds.

 

Summing up some results

 

Both mutual funds and ETFs have their own advantages. But maybe it’s time to rethink your investment portfolio and decide if it is serving as needed?

If a mutual fund has a high expense ratio or is spending too much money on taxes due to unwanted allocation of capital gains, switching to an exchange-traded fund is an excellent choice.

Reallocating investments from an indexed mutual fund to an ETF can reduce costs. On the other hand, if you prefer an actively managed fund that aims to outperform the market, mutual funds certainly offer more options. Although you should not forget about the exchange-traded funds with high risks and therefore with great rewards.

If you are satisfied with both investment options, then nothing is holding you back against choosing two.

Invest wisely.

Editorial – The ESG-zation of the asset management industry

 

This article is not advertisement and a call to invest. The content that we write and publish have only information character and is the subjective opinion of the author.

 

 

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