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 mutual funds, but such instruments can be purchased or sold throughout the trading business day.
Below are the types of exchange-traded fundsExchange-traded FundsAn exchange-traded fund (ETF) is a security that contains many types of securities such as bonds, stocks, commodities, and so on, and that trades on the exchange like a stock, with the price fluctuating many times throughout the day when the exchange-traded fund is bought and sold on the exchange. –
#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 fundsMutual FundsA mutual fund is an investment fund that investors professionally manage by pooling money from multiple investors to initiate investment in securities individually held to provide greater diversification, long term gains and lower level of risks. having a portfolio of bonds. The bonds can range from corporate bondsCorporate BondsCorporate Bonds are fixed-income securities issued by companies that promise periodic fixed payments. These fixed payments are broken down into two parts: the coupon and the notional or face value., 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 correlationNegative CorrelationA negative correlation is an effective relationship between two variables in which the values of the dependent and independent variables move in opposite directions. For example, when an independent variable increases, the dependent variable decreases, and vice versa. 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 managersPortfolio ManagersA Portfolio Manager is an executive responsible for making investment decisions & handle investment portfolios for fulfilling the client’s investment-related objectives. Also, he/she works towards maximizing the benefits & minimizing the potential risks for clients. . They do investment researchInvestment ResearchInvestment research entails analyzing the performance of various financial instruments such as stocks, mutual funds, bonds, debentures, and so on in order to present an investor with a view of how the firm is performing. It also aids in predicting their future performance for price movements. 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 makersMarket MakersMarket makers are the financial institution and investment banks which ensures enough amount of liquidity in the market by maintaining enough trading volume in the market so that trading can be done without any problem. 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 fundsIndex FundsIndex Funds is a form of mutual fund constructed to replicate and match the performance of a particular country's index like S&P, NASDAQ, etc., and helps investors take broad market exposure due to the amount invested in various stocks of the different sectors of the economy. 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 investmentPassive InvestmentPassive investing is a strategy used by investors to maximize their returns by avoiding frequent portfolio churning by buying and selling securities and instead buying and holding a diverse range of securities. 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 an economical cost structureEconomical Cost StructureCost Structure refers to those costs or expenses (fixed as well as variable costs) which businesses will incur or will have to incur to produce the desired objective of the business; such costs include the cost of purchasing the raw material to the cost of packaging the finished products. 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 investorsRetail InvestorsA retail investor is a non-professional individual investor who tends to invest a small sum in the equities, bonds, mutual funds, exchange-traded funds, and other baskets of securities. They often take the services of online or traditional brokerage firms or advisors for investment decision-making. 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 arbitrageArbitrageArbitrage in finance means simultaneous purchasing and selling a security in different markets or other exchanges to generate risk-free profit from the security's price difference. It involves exploiting market inefficiency to generate profits resulting in different prices to the point where no arbitrage opportunities are left. 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 investorsEquity InvestorsAn equity investor is that person or entity who contributes a certain sum to public or private companies for a specific period to obtain financial gains in the form of capital appreciation, dividend payouts, stock value appraisal, etc. 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 plansDividend Reinvestment PlansThe dividend reinvestment plan is the option chosen by the investor to reinvest the amount of cash dividend payable by the company in new shares of the underlying securities on the date of dividend payment..
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 marketsFinancial MarketsThe term "financial market" refers to the marketplace where activities such as the creation and trading of various financial assets such as bonds, stocks, commodities, currencies, and derivatives take place. It provides a platform for sellers and buyers to interact and trade at a price determined by market forces..
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 –