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An ETF is an Exchange Traded Fund, which means that unlike most mutual funds that are priced and exchangeable only at the end of each day the ETF can be bought or sold throughout the day. The price you can obtain for buying or selling your shares will fluctuate during the day largely reflecting the changing prices of the index constituents.
ETFs are securities approved for listing on a national stock exchange after significant review by the Securities and Exchange Commission (SEC). ETFs have been available since 1993 as an efficient mechanism for packaging an investment designed to match performance of an Index.
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| Indexed investments seek to track the returns of a specific stock or bond benchmark, or index. An indexed investment replicates as closely as possible the investment results of the target index by holding all or in cases of very large indexes, a representative sample of the securities in the index. This strategy differs from the traditional active money management style where the manager holds a smaller selection of securities the advisor believes will outperform its index. Indexing takes a passive approach, focusing instead on broad representation within a sector and low trading activity. While investors have to pay to invest in indexed investments, there are a variety of characteristics that make index funds very appealing to investors. |
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| The issuer of an ETF is the Trust and is commonly called the “fund.” The fund’s investment objective is defined in the prospectus which will be closely tracked with the performance of a specified index or defined broad asset class. To achieve this objective, the fund will act according to the instructions provided by the investment advisor and/or the sponsor. The investment advisor or the sponsor will direct the fund to add and/or remove securities from the portfolio based on changes in the specified index. |
| ETFs are different from "closed-end" funds in many ways; one of the more important differences is that "closed-end" funds issue a finite number of shares. ETFs, however, are structured as open-end investment management companies or unit investment trusts - continuously issuing new shares and redeeming existing shares. This provides needed liquidity for the buy and sell sides of the market. However, these transactions with the fund itself may only be done in very large size transactions referred to as Creation Units, and are done by depositing with or receiving from the ETF the actual securities that are part of the index, not just cash. Because of their large size, these transactions are done by institutional investors, and they provide for an arbitrage between the price of the ETF on the Exchange and the price at which an institution can create or redeem from the fund. It is this arbitrage situation that permits the ETF to avoid the kinds of discounts. |
| What is the Creation and Redemption process for an ETF? |
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| The number of shares outstanding in an ETF is not fixed, hence they are often called, “open ended” exchange traded funds. Since an ETF will continuously offer new shares for sale to the market place, there is a process in place to create those ETF shares. To do this without disrupting the balance between supply and demand in the market place, the creation and redemption process is a transfer of shares, “in-kind.” The new ETF shares are typically created in large blocks, called creation units. The in-kind creation process occurs at the end of the day at the fund’s Net Asset Value (NAV). For example, an Authorized Participant will deliver to the fund administrator the specified basket of securities that represent the fund’s portfolio. |
| If you wish to buy or sell shares, this is not done directly through the fund. ETFs trade like stocks, so the transaction will occur on an exchange using a broker. The same order types used for stocks are applicable when conducting ETF transactions, such as market orders, limit orders, stop orders, etc. |
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