Exchange Traded Funds are similar to stocks and traded in the stock exchanges. ETF trades assets namely bonds, stocks and commodities at values close to the NAV or the net asset value in the trading day. Exchange Traded Funds most of them are linked with an index or the other. The popular and vital indexes are MSCI EAFE and S&P. ETFs pose themselves as attractive investment options due to their characteristics similar to stock, tax efficiency as well as low cost. ETFs are the popular exchange traded products which only the large institutions with proper authorization, called authorized participants can trade.
Way back in the year 1989, Exchange Traded Funds started with a proxy S&P 500 called Index Participation Shares that was exchanged on the famous American Stock Exchange as well as Philadelphia Stock Exchange. The product however, did not stay for long as a successful law suit by Chicago Mercantile Exchange stopped the sales in the whole of U.S. In the very next year, however, a product similar to this started being traded on Toronto Stock Exchange. This was known as Toronto Index Participation Shares. These became popular as they were aligned to TSE 35 and in later times tracked the TSE 100 stocks. Its stupendous popularity made the American Stock Exchange sit up and make efforts in developing similar products that will be approved by the SEC of the United States of America.
As per these lines of thoughts, in 1993, a similar kind of product was developed by the duo Steven Bloom and Nathan Most. Both were the executives working closely with the American Stock Exchange. They successfully designed and created Standard & Poor’s Depository receipts. Called ‘Spiders’ for SPDR, this grew to be the biggest among the Exchange Traded Funds of the world. In the month of May in 1995, there were introduced the Mid Cap SPDRs. The year 1998 saw the introduction of sector spiders. In the year 2000, Barclays Global Investors undertook efforts to strengthen the distribution and education of ETFs to attract and retain long term investors. By end 2010 there were 916 Exchange Traded Funds in U.S.
The stock in the Exchange Traded Funds can be traded all throughout the day similar to the stocks on securities exchange. This has to be done with the help of a stock broker. ETFs are similar to mutual fund in many ways and offers great investing options to public investors. ETF is traded only in large sets and by financial institutions. The size of ETF may vary from 25,000 to up to 2, 00,000 shares and these are called the ‘creation units’.
Lesser costs - ETFs have lower costs than other investments due to lesser overhead like marketing and administration costs as well as because are not actively managed.
Flexibility in trading - Can be traded at any time during the day at prevailing market prices unlike mutual funds or unit trusts which are traded only at the end of the day.
Tax efficiency - ETFs need not fulfill investor redemptions by selling securities. Also there are lower capital gains due to lower turnover.
Diversification and market exposure – You can ‘equities’ cash or rebalance portfolio allocations in a convenient manner.