Exchange Traded Funds:Types of Funds

ETF

is an acronym for exchange traded fund. ETFs are investment vehicles that comprise of a number of securities or a basket of assets. They are traded just like stocks on a stock exchange. Most ETFs track an index such as the S&P 500 or the Dow Jones Industrial Average.

Features such as tax efficiency, low cost and stock-like characteristics make ETFs a highly attractive investment option. Exchange traded funds have been available in the US financial market since 1993 and in the European market since 1999.

Features of an ETF

The undivided interest that an ETF offers in a pool of securities makes it similar to the traditional mutual funds. However, unlike a mutual fund, shares in an exchange traded funds:

Can be traded, just like the stocks, through a broker on a securities exchange throughout the day.

Are not sold or redeemed at their net asset value.

ETF shares are purchased and redeemed directly from the exchange traded fund by financial institutions. This is done only in large blocks, varying from 25,000 to 200,000 shares. These are called 'creation units'. The purchase or redemption of these creation units is generally in kind. Institutional investors contribute or receive a basket of securities of the same type and proportion that is held by the concerned ETF. In some cases, the substitution by cash may be required or permitted for purchase or redemption.

The Trading of an ETF

A share of an ETF can be obtained or redeemed directly from fund managers only by large institutional investors. Such institutional investors are also called authorized participants. They may either hold the ETF shares or act as market makers in the open market. Other individual investors use a retail brokerage for trading ETF shares in the secondary market created by these authorized participants.

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