What is the Full Form of ETF?
The Full Form of ETF stands for Exchange Traded Funds. It can be termed as the financial instruments that are formed by utilizing the collection of securities such as shares, bonds or it can be derived from the index. This type of financial instrument can be compared with the mutual funds but such instruments can be purchased or sold throughout the trading business day.
Below are the types of exchange-traded funds –
#1 – Stock ETFs
These ETFs are formed by the formulation of equities in the portfolio. They display similar behavior to an index. These exchange-traded funds have regular stocks in their portfolios and display all properties or characteristics similar to the stocks. By investing in the stock ETFs, the investor gets an opportunity to invest in the basket of stocks.
#2 – Sector ETFs
A sector exchange-traded funds are a type of ETF that either invests in stocks, bonds or asset classes that highlight or focuses on the specific industry. They may formulate an index by focusing on the benchmark parameters.
#3 – Bonds ETFs
A bond ETFs are defined as the exchange-traded funds that exclusively invests in the debt securities and bonds wherein such instruments can be compared with the mutual funds having a portfolio of bonds. The bonds can range from corporate bonds, public bonds, and government bonds.
#4 – Commodities ETFs
The commodities exchange-traded funds are that form a portfolio of commodities. The commodities could range from gold, silver, and metals. Normally, commodities have a negative correlation with stocks and bonds.
#5 – Currency ETFs
The currency exchange-traded funds are that financial products that hold foreign currencies as part of the portfolio. They are generally formed to gain access to the foreign markets and thereby avoiding foreign trades.
#6 – Real Estate ETFs
This is defined as the exchange-traded funds which make investments in real estate developers, real estate investment trusts, real estate service companies, and mortgage-backed securities. These could also be the collections of commercial properties.
# 7 – Actively Managed ETFs
These exchange-traded funds are that are actively managed by the team of experts and portfolio managers. They do investment research and shortlist the best performing asset classes that could be utilized for building ETF.
#8 – Index ETFs
These are exchange-traded funds that focus on the specific index or sectoral indexes or index which belongs to stocks, bonds or commodities.
How does ETFs Work?
The market makers or the authorized participants present in the financial markets approach the ETF manager. The ETF manager helps in the creation of the investment basket maintaining a parallel communication channel with the authorized participants.
The authorized participants then go to financial markets and purchases stocks in the right percentages or utilize the shares it holds and delivers them to the ETF manager. A similar process is carried out for the redemption process and the basket formed from it is termed as the redemption baskets.
Suppose the exchange-traded fund is trading at $64 on the exchange-traded fund’s exchange. However, the authorized participant observes that the fair market value for the exchange-traded funds is at $63.85. The authorized participant would buy the units from the creation basket at the price of an actively traded price.
As the financial system is dynamically changing, the exchange-traded funds have emerged as the popular investment choices among small and large size Investors. The flexibility of actively trading them on markets adds towards their perspective of utilizing it as an investment vehicle.
ETF vs Index Funds
- The index funds are defined as the passive investment funds that have a portfolio of asset classes or stocks that are part of the index itself. They have only those stocks that are part of the index and thereby the manager tracks their performance in line with the market index. Whereas, the exchange-traded funds are defined as the funds which are formulated by utilizing asset classes and not just focusing or monitoring a specific index.
- Index funds can’t be used for active investment practices or styles. They can be utilized for passive investment styles only as there could be high transaction costs in the case of active investment strategies. Whereas, the exchange-traded funds can be formulated using both active investment style and passive investment style.
- It offers low transaction fees and costs.
- The investor generally has to pay fewer expense ratios and normally have economical cost structure in comparison with the mutual funds.
- Generally, there are no exit load fees on exiting the exchange-traded funds.
- These funds are accessible to the markets and make it easier for individual retail investors to invest in emerging stocks, commodities, and bonds.
- There is the availability of margin facility and hence it could be utilized for sophisticated trading strategies.
- It offers huge transparency in terms of fund operation as compared with the mutual funds and hedge funds.
- These funds make daily disclosures on their portfolios and risk management practices promoting investor awareness.
- These funds are traded throughout the business or trading day and hence are more liquid than the mutual funds.
- They have well established and organized secondary markets.
- Due to immediate creation and redemption of exchange-traded funds, along with balancing in arbitrage pricing.
- The ETFs are more tax-friendly as compared with mutual funds.
- The funds normally have less turnover in the portfolio maintained and hence carry less short-term capital gains which reduce taxes substantially.
- They generally hold high exposure to the bigger asset classes which are not monitored or unattended by the investors who invest in such instruments.
- The equity investors may be unaware of the level of the risk assumed to the unknown asset classes as part of the portfolio.
- The ease of access offered by the ETFs could be easily manipulated and traded thereby causing loss to small investors.
- The biggest limitations are that the investors never get the option of reinvesting their dividends or they don’t offer dividend reinvestment plans.
The exchange-traded funds are investment vehicles derived from the asset classes or from asset classes belonging to specific sectors. The asset classes can range from stocks, bonds, and commodities, etc. They offer extensive flexibility and liquidity to the investors who choose to invest in the financial markets.
This has been a guide to the Full Form of ETF (Exchange Traded Funds). Here we discuss how does ETF Work along with types, example, importance, benefits, and differences. You can learn more about financing from the following articles –