Exchange traded funds, or ETFs, are one of the fastest growing investment vehicles in the world.
Having first appeared in the early 1990s, at the end of November 2015 there were more than 4,400 ETFs globally and close to 250 providers. They accounted for some 2.8 trillion US dollars in assets in over 9,300 listings on 61 exchanges – quite a feat for a product that was virtually unknown just 20 years ago.*
So what is this new breed of investment?
Like a mutual fund, an ETF is an investment vehicle that creates shares and then uses the funds to build a portfolio of securities. Most often this portfolio has the goal of tracking a benchmark index – like the S&P 500 or DAX – as closely as possible. This means the price of an ETF’s shares is generally tied to the performance of the underlying market its index represents. Due to the special way ETFs are structured, these shares can also be traded on exchanges like stocks (hence the name “exchange traded” fund).
A host of advantages
Thanks to their special characteristics, ETFs provide investors with many advantages. One of these is flexibility. Generally liquid, ETFs can be used for a wide range of trading strategies or to access specific market segments. They are also very transparent: ETF share prices are updated almost in real time, while their holdings are published daily.
With ETFs covering almost every conceivable market, asset class and investment theme, they are also excellent tools for portfolio construction. ETFs normally have low fees as well, making them a cost-effective way to diversify a portfolio and implement a wide range of investment strategies across multiple asset classes.
Of course, ETFs have their own risks too. Like any investment, their value can fall as well as rise. ETFs are also not all equally liquid, nor are they all equally well-managed. It pays to be informed.
As their growing popularity shows, many investors who look into ETFs like what they see. True up and comers of the investment world, they can be an excellent addition to both private and institutional portfolios.