Understanding ETFs
ETFs are an investment vehicle that provide access to a wide range of asset classes including equities, fixed income and commodities.
The majority of ETFs are passive which means they track an index such as the S&P 500 or MSCI World, however, many asset managers have started to offer active ETFs that look to outperform the market.
When an investor buys shares of a passive ETF, they are investing in a diversified portfolio that looks to mirror the performance of an underlying index.
ETFs vs mutual funds
Much like mutual funds, ETFs offer exposure to diversified baskets of securities, however, unlike mutual funds, ETFs trade on an exchange, a key difference between the two structures.
While mutual funds are typically priced and traded at the end of the trading day, ETFs can be traded on a stock exchange at any time during market hours. Their prices are updated throughout the trading day, allowing investors to buy or sell shares, much like stocks.
In other words, when investors buy or sell shares in a mutual fund, they are transacting directly with the fund, whereas ETFs trade on the secondary market. Unlike stocks and ETFs, mutual funds trade only once per day after the markets close.
Intraday trading
The ability to trade intraday allows ETF investors to react to market movements quicker than investors in mutual funds.
Another advantage of ETFs over traditional mutual funds is they tend to carry lower fees. Highlighting this, the cheapest S&P 500 ETF in Europe is the SPDR S&P 500 UCITS ETF (SPY5) which has a total expense ratio (TER) of just 0.03%.
Investors can choose from a wide range of ETFs that can meet different investment objectives. There are equity ETFs that focus on stocks, fixed income ETFs, commodity ETFs and thematic ETFs that target specific megatrends.
Other types of ETFs include active ETFs, ESG ETFs which are on the rise as investors become increasingly sustainability-focused and regulations tighten and smart beta ETFs.
Democratising investing
Their transparency, liquidity, and flexibility have driven an increase in their market share since the first ETF was launched in the US in 1993.
They are one of the greatest inventions in modern finance and have revolutionised investing for both professional and retail investors alike.
Key takeaways
ETFs offer a convenient way to invest in a diverse range of assets including stocks, bonds and commodities, through a single trade
Unlike mutual funds, ETFs trade throughout the day, allowing investors to react to market movements quickly and buy or sell shares at any time
ETFs generally have lower fees than actively managed mutual funds, making them a more cost-efficient way to invest.
