What is an ETF?

An Exchange Traded Fund (ETF) is an index-tracking fund traded on the stock exchange, the same way as stocks are traded. 

The best of two worlds

An ETF is a mutual fund

An exchange-traded fund is a fund that you buy and sell on the stock exchange, just as you trade equities. An ETF is subject to the same strict regulations and supervision as traditional funds. 

An ETF invests the capital received from investors (unit-holders) in the assets that comprise of the fund’s investment strategy. The fund's assets are held by a custodian, separate from the other assets of the fund management company. 

Each unit of an ETF represents an ownership stake in the fund's net assets. This is the attribute that primarily distinguishes ETFs from other exchange-traded products, such as certificates, which do not have any underlying assets. Instead, the issuer of the product, usually a bank, makes a commitment to provide investors with the returns on the product. The holder of such a product runs the risk that the issuer is unable to meet its financial commitments. 

An ETF is an index fund

In most cases, an ETF is an index-tracking fund. In an ETF, you get the same risk diversification that you achieve in a traditional index fund. By investing in an ETF you can easily and at low cost gain immediate exposure to the market in which you have chosen to invest, such as an equity or fixed income market in a particular region, a broad basket of commodities or a specific equity sector.

The major difference between an ETF and a traditional index fund is that an ETF is traded on the stock exchange, which means it is priced and can be bought and sold in real time, just like equities.

Trading on the stock exchange means that you can quickly and easily monitor the daily movements of the market in which you are invested. An ETF is therefore an investment alternative for active investor who wants to take advantage of market fluctuations, just as quickly and easily as you would trade equities. However, an ETF can also be an excellent option for long-term savings, particularly considering their low fees. 

An ETF is traded and priced in real time on the stock exchange

An ETF is priced in real time

The primary difference between an ETF and a traditional fund is that an ETF is traded and priced in real time on the stock exchange. As the price of the underlying assets of the ETF changes during the day, the price of the ETF will change. When you place your order during the day, the trade will be completed at the price prevailing at the moment when the order is executed.

As with trading in equities, a buy and sell order for an ETF can be limited, as well as it is possible to use stop-loss orders. An ETF can also be sold short and lent. 

Traditional funds are priced just once a day

Most traditional funds are only priced once a day. In this case, it does not matter when an order is placed, because the price is the same for everyone. With an ETF, you decide when you want to trade during the day, and you pay the price prevailing at the moment that your order is executed.

Quotations for Xact ETFs are displayed here. 


Low Management fees

An ETF has a low management fee. One reason is that most ETFs are index funds for which the manager does not have to take active investment decisions. Instead, the fund invests in the assets and in the proportion, included in the benchmark index. Consequently ETFs can be managed at a lower cost than traditional actively managed funds.

Investors bear its own cost

In a traditional fund, unit-holders’ deposits and withdrawals are made directly with the fund. As a result, the manager must buy and sell securities to equal the deposits to and withdrawals from the fund, thereby incurring expenses in the form of brokerage fees and other transaction costs. Furthermore, in an actively managed fund the manager buys and sells securities to increase returns for unit-holders, which also entails expenses for the fund. All of the fund’s expenses affect all unit-holders equally through a corresponding decline in the return of the fund, which is a disadvantage for long-term investors.

In an ETF, outstanding units are traded on the stock market, not directly with the fund. The cost for you as an investor to trade an ETF is the commission you pay to your broker and the spread.

For trading and prices on the stock exchange to work, Xact has agreements with various market makers who can create and redeem fund units directly with the fund. As payment for new fund units, the fund receives the underlying basket of securities that make up the fund´s benchmark index, i.e the fund does not have to purchase the securities in the market. Consequently an ETF usually has extremely low transaction costs. So, even if many investors buy and sell fund units on the stock exchange, you will not be affected as a unit-holder. Everyone covers their own costs in an ETF, through the commission paid to the broker. 


An ETF is transparent

The passive management strategy, which characterizes an ETF, makes the fund transparent and predictable. 

An ETF is transparent

An ETF is transparent. An ETF does not offer any surprises due to the passive management strategy; it moves just like the market it tracks.

The holdings of the ETF are disclosed on a daily basis. Clarity and transparency make ETFs an efficient building block when constructing an investment portfolio. Investing in a variety of ETFs that track different markets allows you to easily and inexpensively build a portfolio with the diversification of markets and asset classes that you want to achieve. Since the ETF is traded on the stock exchange in real time you can quickly and effectively modify your exposure in response to changes in market sentiment.

Daily disclosure of exposure

On a daily basis a portfolio composition file (PCF) is published disclosing all of the ETF’s holdings. Since the ETF reflects the performance of an index, the securities shown in the PCF will be the same as the securities included in the relevant index. The PCF provides the investor with daily insight into the fund's holdings of equities or other securities, allowing the investor to avoid unwanted overweight in the same securities in other portfolios.

The PCF also show the securities and its share of the fund's total holdings to be delivered when a market maker wants to create or redeem units directly with the fund.

An effective tool in your portfolio

An ETF can be used as a long-term strategic investment as well as for tactical adjustments in the portfolio to achieve a temporary exposure. 

The clear and transparent investment strategy demonstrated by an ETF, combined with the low costs associated with trading, make ETFs excellent building blocks for creating various investment portfolio strategies.


Effective for asset allocation

Allocation between different asset classes such as for example equities, fixed income and commodities is more important than the ability to cherry-pick. Fixed income and commodities often provide a dampening effect in a portfolio when the stock market falls, while creating opportunities for good returns when the market rebounds.

ETFs make it easy to build a portfolio based on the desired allocation of various asset classes. Suppose you want a portfolio with 60 per cent equities, 30 per cent fixed income and 10 per cent commodities. With only three ETFs, the asset allocation is achieved, easily and cost-effectively. 

Effective for diversification

Investing in several different securities within the same asset class provides diversification, which enables spreading the risk.

An ETF tracks an index consisting of many underlying securities. Thus an ETF easily and cost effectively provides good risk diversification. Suppose you intend to invest 60 per cent of your capital in the stock market. You could buy an ETF that tracks a broad underlying US equity index consisting of several hundred companies. But a better strategy might be to allocate capital among different regions and sectors. If the US stock market suddenly plummeted, your overall equity exposure would not necessarily be affected to the same extent.

ETFs allow you to easily and cost-effectively achieve the desired portfolio diversification. 

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Data source

This information is updated every 15th minute from Handelsbanken. Xact does not assume any liability for errors in the information.