Exchange Traded Funds Essay

1566 words - 7 pages

Exchange Traded Funds may be defined as the securities which resemble the index funds closely, but can be sold and bought during the day, somewhat similar to common stocks. These investment securities give investors a sophisticated way to purchase a broad basket of securities in a single transaction. It may be said that the ETFs offer their investors the convenience of a stock along with the diversification of a mutual fund.”
According to the SEC, ETFs “are investment companies that are legally classified as open-ended companies or Unit Investment Trusts.”
ETFs in general track indices, such as the Standard & Poor 500 or the Dow Jones Industrial Average or. Depending on the strategy of ...view middle of the document...

The sponsor creates a portfolio composition file which lists the weights and composition of the underlying securities or commodities that tend to mirror the target index.
Then the APs buy or borrow (as per their desire and capacity) relatively large amounts of the underlying stocks from the capital markets that would tend to mirror the target index. If the proposed ETF is made to track a commodity, then the APs buys or borrow certificates of ownership of that commodity.
Then a basket of securities is prepared and is delivered to the custodian. The custodian then verifies whether the prepared basket is an approximate mirror of the target index. After verification, the AP receives a “creation unit” which is then delivered to the account at the Depository Trust Corporation. At the last step, the creation unit is broken up into ETF shares. Each ETF share represents a fraction of the creation unit. The number of ETF shares depends on the Net Asset Value (NAV) of the creation unit which is a function of the weights assigned to the underlying securities.
If it is the case of commodities then the sponsor normally has a formula to calculate the NAV.
ETF – New Investment Avenue
ETFs popularity is grounded in the reasons outlined below:
1. Tax Efficiencies

ETFs, in general, are more tax efficient than the open-ended mutual funds.

2. Flexibility
ETFs generally can be customized to track almost any index.
3. Low Fees
With a lower expense ratio than their mutual fund counterparts, ETFs typically have lower marketing, distribution, and accounting expenses and most ETFs do not have 12b-1 fees.
4. Pricing and Trading
ETFs trading are done on exchanges similar to common stocks. Consequently, their intraday indicative value gets updated after almost every 15 seconds.

5. Diversification

ETFs, in general, are more diversified than open-ended mutual funds the reason being that ETFs typically seek exposure to broad indices.

6. Transparency

The ETFs are considered very transparent investment as ETFs disclose all the information related to the composition and weights of the underlying base.

7. Investment in Commodities allowed

Normally, investing in commodities is cost-prohibitive for almost most retail investors because the retail investors cannot afford to buy in ‘huge-sizes.’
ETFs allow the retail investors to buy commodity lots in much smaller pieces like a single ETF share. Consequently, many retail investors have been benefitted from the increase in commodity prices over the past few years.

Popular Families of ETFs

SPDRs

SPDR stands for Standard & Poor's Depositary Receipts (SPDRs). SPDRs are managed by State Street Global Advisors. The most popular SPDR among the family is the SPDR S&P 500 EDF (SPY) which tracks the S&P 500 Index but it need to be kept in mind that State Street Global Advisors also offers a series of ETFs that track almost all the major S&P 500 sectors. Such ETFs are...

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