An exchange traded fund (ETF) is a basket of securities — such as stocks, bonds, currencies or commodities — that can be bought and sold in a single trade on an exchange. They generally track the performance of an index, may charge less fees, and offer targeted exposure to a specific market segment, such as an asset class, geography, sector, or investment theme. In essence, ETFs are funds that trade like stocks with the diversification benefits of mutual funds. In one trade, they may offer diversified, low-cost, transparent, and tax-efficient exposure to companies across the globe.
What Are the Benefits of ETFs?
Understanding the benefits of ETFs is an important step toward determining whether ETFs can be an appropriate choice for your portfolio
Targeted Exposure— ETFs generally track an index, offering exposure to a specific segment of the market such as:
Asset classes: ETF proliferation has helped make all market segments easy to access, from equities and fixed income, to commodities and alternatives.
Geographies: You can access global, regional, or single country focused ETFs, as well as ETFs that focus on developed or emerging markets.
Currencies: ETFs that track the price return of a basket of currencies, such as all emerging market currencies, or individual ones, such as the Japanese Yen or Chinese Yuan
Sectors and Industries: These ETFs track a stock market sector or industry, such as Industrials, Health Care, Homebuilders, or Technology.
Investment Themes: These ETFs seek to offer exposure to multi-generational investment themes such as Environmental Social Governance (ESG) or the advancement of technology on Cyber Security or Autonomic Vehicles.
Style/Factors: Smart beta ETFs offer exposures to stocks with attributes like low volatility, value, and momentum.
Lower Expense Ratios— Because most ETFs are passively managed, they typically have lower management fees and operating expenses compared to mutual funds. Transaction costs are minimized due to the low turnover of most ETFs and the indexes they track. When fees and expenses are low, investors can keep more of their returns.
Increased Diversification— ETFs provide one of the easiest ways to diversify a portfolio.
They provide access to many companies or investments in one single trade, removing single stock risk — the risk inherent in being exposed to just one company. Offering this exposure in the ETF structure helps to lower the risk that a select number of individual stocks could hurt overall portfolio performance.
Added Liquidity— ETFs benefit from two sources of liquidity:
Primary Market Liquidity: ETFs have a unique creation/redemption mechanism, which allows Authorised Participants (APs) to build baskets of ETF shares when demand increases (creation), or disassemble the baskets of ETF shares back into single securities should demand decrease (redemption). This happens in the primary market, and allows the liquidity of an ETF’s underlying securities to enhance the liquidity of the ETF.
Secondary Market Liquidity: Because they trade throughout the day on an exchange, or in the secondary market, investors can make timely investment decisions and quickly execute based on shifting market conditions.
Tax Efficiency— ETFs are generally more tax efficient than other investment vehicles due to the ability to transfer securities in and out of the portfolio in the most tax-efficient manner, via the in-kind creation/redemption process. And, because ETFs generally track market indexes, turnover is generally low, resulting in fewer capital gains and lower taxes. Additionally, any associated capital gains taxes are paid at the time of final sale, offering greater control on the timing of tax consequences.
Flexible Trading— ETFs can be bought through an online brokerage account at their current market price, at any time during the trading day. There are no minimum holding periods, and investors can employ a wide range of trading techniques — such as buying on margin, short selling, and placing limit orders — to react to market movements.
Increased Transparency— The holdings of most ETFs are fully transparent and available daily. This disclosure means investors know what they own at any moment, allowing them to make more informed investment decisions with greater accuracy.
The Global ETF Market
ETFs have grown exponentially since 1993 when State Street Global Advisors launched the SPDR® S&P 500 ETF Trust (SPY), the first US-listed ETF. Today, investors use ETFs to precisely meet their individual portfolio needs, from finding income and gaining broad market exposure, to lowering costs and investing in difficult-to-reach markets.
State Street Global Advisors launched the first US-listed ETF: SPDR® S&P 500 ETF Trust (SPY)
Total number of global exchange traded funds available. 1
Global assets under management in ETFs and ETPs 1
1ETFGI, as of 12/31/2021.
Authorized Participant (AP)
A US-registered and self-clearing broker-dealer who meets certain criteria and signs a participant agreement with a particular ETF sponsor or distributor to become an “authorized participant” of the fund. APs are often associated with large and influential investment banks, and are scrutinized for their integrity and operational competence as they are the only parties who transact directly with an ETF.
Creation and Redemption Process
The process whereby an ETF issuer takes in and disburses baskets of assets in exchange for the issuance or removal of new ETF shares.
An order placed with a brokerage to buy or sell a set number of shares at a specified price or better.
The degree to which an asset or security can be bought or sold in the market without affecting the asset’s price. Liquidity is characterized by a high level of trading activity.
The market where shares of an ETF are created or redeemed.
A market where investors purchase or sell securities or assets from or to other investors, rather than from issuing companies themselves. The New York Stock Exchange and the NASDAQ are secondary markets.
Investing involves risk including the risk of loss of principal.
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All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.
Equity securities may fluctuate in value and can decline significantly in response to the activities of individual companies and general market and economic conditions.
Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.
Frequent trading of ETFs could significantly increase commissions and other costs such that they may offset any savings from low fees or costs.
Diversification does not ensure a profit or guarantee against loss.
Passive management and the creation/redemption process can help minimize capital gains distributions.
There can be no assurance that a liquid market will be maintained for ETF shares.
While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.
Because of their narrow focus, sector investing tends to be more volatile than investments that diversify across many sectors and companies.
Non-diversified funds that focus on a relatively small number of [stocks, issuers, countries] tend to be more volatile than diversified funds and the market as a whole.
Foreign investments involve greater risks than U.S. investments, including political and economic risks and the risk of currency fluctuations, all of which may be magnified in emerging markets.
Currency Risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged.
Low volatility funds can exhibit relative low volatility and excess returns compared to the Index over the long term; both portfolio investments and returns may differ from those of the Index. The fund may not experience lower volatility or provide returns in excess of the Index and may provide lower returns in periods of a rapidly rising market. Active stock selection may lead to added risk in exchange for the potential outperformance relative to the Index.
The returns on a portfolio of securities which exclude companies that do not meet the portfolio's specified ESG criteria may trail the returns on a portfolio of securities which include such companies. A portfolio's ESG criteria may result in the portfolio investing in industry sectors or securities which underperform the market as a whole.
A Smart Beta strategy does not seek to replicate the performance of a specified cap-weighted index and as such may underperform such an index. The factors to which a Smart Beta strategy seeks to deliver exposure may themselves undergo cyclical performance. As such, a Smart Beta strategy may underperform the market or other Smart Beta strategies exposed to similar or other targeted factors. In fact, we believe that factor premia accrue over the long term (5-10 years), and investors must keep that long time horizon in mind when investing.
The trademarks and service marks referenced herein are the property of their respective owners. Third party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data.
Passively managed funds invest by sampling the index, holding a range of securities that, in the aggregate, approximates the full Index in terms of key risk factors and other characteristics. This may cause the fund to experience tracking errors relative to performance of the index.
ETFs trade like stocks, are subject to investment risk, fluctuate in market value and may trade at prices above or below the ETFs net asset value. Brokerage commissions and ETF expenses will reduce returns.
Standard & Poor's®, S&P® and SPDR® are registered trademarks of Standard & Poor's Financial Services LLC (S&P); Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC (Dow Jones); and these trademarks have been licensed for use by S&P Dow Jones Indices LLC (SPDJI) and sublicensed for certain purposes by State Street Corporation. State Street Corporation's financial products are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates and third party licensors and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability in relation thereto, including for any errors, omissions, or interruptions of any index.
Distributor: State Street Global Advisors Funds Distributors, LLC, member FINRA, SIPC, an indirect wholly owned subsidiary of State Street Corporation. References to State Street may include State Street Corporation and its affiliates. Certain State Street affiliates provide services and receive fees from the SPDR ETFs. ALPS Distributors, Inc., member FINRA, is the distributor for DIA, MDY and SPY, all unit investment trusts. ALPS Portfolio Solutions Distributor, Inc., member FINRA, is the distributor for Select Sector SPDRs. ALPS Distributors, Inc. and ALPS Portfolio Solutions Distributor, Inc. are not affiliated with State Street Global Advisors Funds Distributors, LLC.
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