An ETF (exchange traded fund) is a collection of securities held in a trust designed either to track the performance of the whole market, or a broad segment, or sector of the market. The shares of ETF trusts trade on the stock exchange.
Many ETFs are designed to track the performance of major global indices like the S&P 500, FTSE, and MSCI, among many others.
There are also ETFs that track specific segments of the market, such as small-caps, mid-caps, large-caps, GICS sectors, emerging markets, and so on, and ETFs that follow commodities, like Gold.
An ETF is similar to an unlisted index mutual fund, or unit trust, in that it pools investments to purchase a diversified index asset base. However, the ETF adds the benefit of being traded on the stock exchange so its shareholders can easily trade it at any time of the trading day at prevailing market prices. Unlisted funds cannot offer this and are very limited in how their shares can be purchased and sold.
Like most mutual funds, most ETFs invest in the physical assets they are tracking, however, it is important for investors to distinguish when ETFs do not use a physical backing strategy.
With ETFs, investors also benefit from transparent pricing that comes from liquid, active trading on the stock exchange. Market makers ensure that there is always a bid (buy) and offer (sell) price in the market, so investors can always trade. As with stocks, ETF investors can place stop loss and limit orders on ETFs. ETF shares can even be bought on margin and sold short, subject to your broker’s terms and conditions. These features are largely unavailable with unlisted index funds.
Because of their reach, listing features and flexibility, ETFs can combine these exchange trading benefits with access to thousands of domestic and international indexes, as well as specific sectors or industries (e.g, utilities, technology, healthcare or gold). For these reasons, ETFs have grown exponentially since State Street launched the first US ETF in 1993, the SPDR S&P 500 ETF —see the chart, Global ETF Growth Over The Last 22 Years—with over $4 trillion in assets at the end of 2018.
ETFs offer the advantages of trading throughout the day, with flexible trading options, and no minimum investment requirement outside of the minimum required by brokers to execute a trade.
Invest in the long-term performance of listed markets with the benefit of market-wide diversification using ETFs (exchange traded funds).
The Potential Benefits of Exchange Traded Funds
Diversification: ETFs offer one of the easiest ways to diversify a portfolio, especially for investors who want to focus on a specific sector or industry. By virtue of being index investments, ETFs offer exposure to a particular market segment, helping to protect against the risk of a select number of individual stocks hurting an investor’s overall portfolio performance. It’s important to remember that diversification does not ensure a profit or guarantee against loss.
Lower Fees and Expenses: Because ETFs are passively managed, they typically have low management fees and operating expenses.
Trading Flexibility: ETFs trade all day long, so investors can lock in the market value of the ETF anytime during the trading day. Because ETFs trade like stocks on an exchange, a wider range of techniques (short selling, stop loss and limit orders) can be used to take advantage of anticipated market movements. It is important to keep in mind that frequent ETF trading, which typically occurs through a broker, can significantly increase brokerage commissions potentially washing away any savings from low fees or costs.
Transparency: With ETFs, investors have all the information they need to make informed investments— there is no strategy drift or ‘black boxes’ to decipher. With ETFs that replicate their index or sector with physical backing, you typically know precisely which securities the ETF holds, and what you’re invested in — there is no need to wait for the end of the quarter to review the fund’s holdings.
Replication or physical backing is where the ETF follows the performance of the index or sector by investing the actual assets. State Street ETFs are all physically-backed ETFs.
This approach contrasts with optimization-based strategies that replicate based on sampling, and synthetic strategies that use derivatives—to read more about this, see Some Simple ETF Facts: Debunking Myths & Common Misconceptions.
We pioneered ETFs as a simple, cost effective means of investing in the performance of market indices, with all the benefits of listed market liquidity.
With the American Stock Exchange, we developed and launched the SPDR S&P 500 ETF, the first of its kind in the US, and globally. Since then we have achieved multiple firsts, including launching the first listed ETF in Australia, Hong Kong, and Singapore.*
*ETFs managed by State Street Global Advisors have the oldest inception dates within the US, Hong Kong, Australia, and Singapore. State Street Global Advisors launched the first ETF in the US on January 22, 1993; launched the first ETF in Hong Kong on November 11, 1999; launched the first ETF in Australia on August 24, 2001; and launched the first ETF in Singapore on April 11, 2002.
If exchange traded funds interest you, speak to your advisor or broker to determine if you could benefit from incorporating ETFs into your investment plans. Your advisor can help you analyze your current investments, risk tolerance, tax situation and time horizon, and then recommend strategies to help you achieve your goals.
Diversification does not ensure a profit or guarantee against loss.