ETF stands for exchange-traded fund and they are a sub-section of ETPs or exchange-traded products. ETPs are funds, much like an index or mutual fund in that they contain a basket or bundle of assets. However, unlike index or mutual funds, an exchange traded fund trades on the stock exchanges. In essence, it has the best of both the mutual fund and the stock – the diversification of one and the trading capabilities of the other. It does not have its net-asset value (NAV) calculated daily as a mutual fund would, but rather its price changes as it is bought or sold throughout the day, reflecting the rise and fall in demand.
Advantages and disadvantages
An ETF has the advantages of diversity, much like an index fund, bringing together a whole bundle of assets into one fund and given that it is traded on the stock exchanges, you have the ability to sell short and buy small amounts of shares, even individual shares. The expense ratio of an ETF also tends to be much lower than that of a mutual fund, you can expect to pay what you would on any normal transfer. These unique advantages over index or mutual funds makes them an attractive prospect to investors and the diversity included within them makes them a good option for those who struggle with more individual investments.
ETFs track indexes and as such should reflect the return on these indexes, however not to the exact figure. There can be a difference of over one per cent when the year-end figures of the index and ETF that reflects it are compared, so don’t expect the correlation to be spot on. The first ETF, nicknamed spider, was the S&P 500 index which started life on the trading desks of Wall St back in 1993. Today, however, there are hundreds of them available with various regional and other focuses. You can choose based on the sector you wish to enter into – technology, energy, healthcare, the internet, the list goes on – or choose based on the country or region with many covered by a number of these ETFs.
Short sell of inverse?
While it is possible to short ETFs due to their stock-like trading capabilities, you could also opt for the inverse ETF. These are ETFs which consist of a bundle of assets, but make money from the decline in the value of the index or assets in question rather than from the rise, as is the case with the standard ETF. So you have two options – either shorting an ETF or taking out an inverse ETF which is known in the business as a bear ETF.
The potential benefit of going for the ‘bear ETF’ is that you are not required to hold a margin account, which you would be if you chose to bet against the given index through shorting an exchange traded fund. Many of these bear ETFs are available and similar to standard ETFs offer you the option of a variety of sectors and regions to choose from.