What are ETFs?

Understanding ETFs

ETFs offer many benefits and, if used wisely, are an excellent vehicle to achieve an investor’s investment goals. Essentially a basket of securities that you can buy or sell through a brokerage firm on a stock exchange, ETFs are offered on virtually every conceivable asset class from traditional investments to so-called alternative assets like commodities or currencies. In addition, innovative ETF structures allow investors to short markets, to gain leverage, and to avoid short-term capital gains taxes.

In essence, ETFs are an easy way to invest that tends to have low upfront cost, that is flexible yet also simple, transparent and easy to trade. Learn how ETFs can make your money do more for you minus the relative complexity of many traditional investment products.

ETFs are an easy way to invest that tends to have low upfront cost, that is flexible yet also simple, transparent and easy to trade.

How do ETFs work?

An ETF is bought and sold like a company stock during the day when the stock exchanges are open. Just like a stock, an ETF has a ticker symbol and intraday price data can be easily obtained during the course of the trading day.

Unlike a company stock, the number of shares outstanding of an ETF can change daily because of the continuous creation of new shares and the redemption of existing shares. The ability of an ETF to issue and redeem shares on an ongoing basis keeps the market price of ETFs in line with their underlying securities.

Just like a stock, an ETF has a ticker symbol and intraday price data can be easily obtained during the course of the trading day.

Although designed for individual investors, institutional investors play a key role in maintaining the liquidity and tracking integrity of the ETF through the purchase and sale of creation units, which are large blocks of ETF shares that can be exchanged for baskets of the underlying securities. When the price of the ETF deviates from the underlying asset value, institutions utilise the arbitrage mechanism afforded by creation units to bring the ETF price back into line with the underlying asset value.

Advantages of ETFs

• Easy to trade — you can buy and sell any time of the day, unlike most mutual funds that trade at the end of the day

• Transparency — most ETFs are required to publish their holdings daily; this is not always the case, for example in a managed fund, where the portfolio manager has the discretion to choose not to reveal the investments in the fund.

• More tax efficient — ETFs typically generate a lower level of capital gain distributions relative to actively managed mutual funds

• Trading transactions — because they are traded like stocks, investors can place a variety of order types (e.g., limit orders or stop-loss orders) that can't be made with mutual funds

Disadvantages of ETFs

• Trading costs — if you invest small amounts frequently, there may be lower-cost alternatives investing directly with a fund company in a no-load fund

• Illiquidity — some thinly traded ETFs have wide bid/ask spreads, which means you’ll be buying at the high price of the spread and selling at the low price of the spread

• Tracking error — while ETFs generally track their underlying index fairly well, technical issues can create discrepancies

• Settlement dates — ETF sales are not settled for 2 days following a transaction; that means as the seller, your funds from an ETF sale aren't technically available to reinvest for 2 days

Institutional investors play a key role in maintaining the liquidity and tracking integrity of the ETF through the purchase and sale of creation units, which are large blocks of ETF shares that can be exchanged for baskets of the underlying securities.

ETFs make accessing markets easy

There is usually an ETF for whatever you are looking to invest in, from a country in southeast Asia to an asset class like global bonds — and even commodities like gold. For investors who would like to invest in difficult-to-access markets such as emerging markets, it now becomes straightforward by investing into an ETF.

Investing strategies

Once you've determined your investment goals, ETFs can be used to gain exposure to virtually any market in the world or any industry sector. You can invest your assets in a conventional fashion using stock index and bond ETFs, and adjust the allocation in accordance with changes in your risk tolerance and goals — you can also add alternative assets, such as gold, commodities, or emerging stock markets.

This article is for educational purpose and not to be regarded as investment advice, a recommendation, or an offer or solicitation to subscribe for, buy or sell any investment product. All forms of investments are subject to risks, including the possible loss of the principal amount invested. Losses can exceed your initial deposit. You should carefully consider your investment experience and objectives, financial situation, and risk tolerance level, and consult an independent financial adviser prior to dealing in any investment products. The contents in the article may have been obtained or derived from public or other sources believed by CMC Invest to be reliable. However, unless otherwise specifically stated, CMC Invest makes no representation as to the accuracy or completeness of such sources or the information, and accordingly accepts no liability for loss whatsoever arising from or in connection with the use of or reliance on the information. Please visit www.cmcinvest.com/en-sg/ for important information. This advertisement has not been reviewed by the Monetary Authority of Singapore.