An Exchange Traded Fund (ETF) can be thought of as a mutual fund which trades like a share, often aiming to track stock market indexes like the S&P 500 or commodity prices such as gold, oil or cotton. ETFs are traded intra-day on the stock market and you can buy them from your broker just as you would any other stock. The price of an ETF will change throughout the day, reflecting the fluctuating value of the underlying assets.
The first ETFs originally tracked stock market indexes but there are now ETFs for bonds, commodities, currencies and real estate (REITs). ETFs have become increasingly popular for their low cost, tax efficiency, versatility and transparency. Since 2008 actively managed ETFs have been authorised by the Securities and Exchange Commission.
Types of ETF
- Index ETFs
- Commodity ETFs
- Bond ETFs
- Currency ETFs
- REIT ETFs (Real Estate)
- Actively managed ETFs
- Leveraged ETFs
Attractions of ETFs
Low Costs
One of the most attractive features of ETFs is cost. Mutual funds typically charge an annual management fee of between 1.5% and 2% compared to an average of 0.4% for ETFs and just 0.2% for domestic index tracker ETFs. Over an investment lifetime this can make a big difference to overall returns.
Taxation
When a mutual fund management team realises a capital gain by selling an appreciated share, unless your investments are protected in a retirement account you will be required to pay capital gains tax at the end of the financial year – regardless of whether the overall price of the mutual fund increased or decreased during that year. ETFs however are more cleverly structured such that ETF shares can be bought and sold without any actual trading of the underlying shares. In fact Barclays Bank, which is one of the leading providers of ETF securities, claimed four consecutive years where no capital gains tax was payable by holders of its ETFs. You do have to pay tax on dividends in the usual way, and of course if you sell all or part of an ETF you will have to pay capital gains tax on any profits.
Trading ETFs
Almost all mutual funds require an initial minimum investment of several thousand dollars, however ETFs can be bought in any quantity. ETFs can be purchased during stock market opening hours at the current price, whereas mutual funds are only priced once per day after close. ETFs are also more flexible by being able to be purchased using limit, market or stop-loss orders.
Transparency
Mutual funds rarely disclose which securities they currently hold to their investors, often because they do not want their competitors to know exactly how they are implementing their strategy. ETFs on the other hand are completely transparent so investors know exactly what they are buying.
The Biggest ETFs
According to CNN, the biggest exchange traded funds by assets are:
| ETF | Symbol | Assets |
|---|---|---|
| SPDR S&P 500 | SPY | $91b |
| SPDR Gold Shares | GLD | $69b |
| Vanguard MSCI Emerging Markets ETF | VWO | $46b |
| iShares MSCI EAFE Index | EFA | $38b |
| iShares MSCI Emerging Markets Index | EEM | $35b |
| iShares S&P 500 Index | IVV | $28b |
| PowerShares QQQ | QQQ | $25b |
| iShares Barclays TIPS Bond | TIP | $21b |
| Vanguard Total Stock Market ETF | VTI | $19b |
| iShares Russell 2000 Index | IWM | $16b |
Data as of 30th October 2011