An ETF is a type of mutual fund that replicates an index. Unlike an index fund, however, it is traded like a stock on an exchange. The difference between its performance and that of the index it replicates is called a tracking error. An ETF tries to minimise the tracking error while maximising its performance.

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Unlike other mutual funds, ETFs can be bought and sold on exchanges on a real-time basis. One can even put limit orders of purchase and sale through the exchanges. ETFs also trade throughout market hours. They can be sold short or on margin, and prices are continuously updated during the trading day.

The expense ratios of ETFs are consistently lower than those of actively managed mutual funds, which is to be expected. But they are also lower than those of index funds, as there is only one transaction per trade with an ETF, while an index requires a basket of stocks and multiple trades. Load and management fees are lower, too.

ETFs derive their liquidity in two ways: First, from the trading of the units on the secondary market, and second, through the in-kind creation/redemption process with the fund in-kind creation unit size. Due to the unique in-kind creation/redemption process of ETFs, the liquidity of an ETF is actually the liquidity of the underlying shares.

ETFs can either be purchased on the exchange, through a stock broker, or directly from the fund. The fund creates/redeems units only in predefined lot sizes in exchange for a predefined underlying portfolio basket. Once the underlying portfolio basket is deposited with the fund, together with a cash component, the investor is allotted the units. This is in-kind creation/redemption of units, unique to ETFs.

As ETFs closely track the index they replicate, their returns are close to those generated by the index. The right ETF should, therefore, be one that tracks an index that complements the investment philosophy of the investor.

Yes. ETFs collect the dividends of all its constituent stocks and always pay out the dividends to the ETF shareholder. This can be a cash distribution or a reinvestment in the ETF’s underlying index.

By no means. Any class of asset that has a published index around it and is liquid can constitute an ETF. Bonds, real estate, and gold ETFs have been available for some time.

Yes, very. The list of assets are published on a daily basis and are, therefore, transparent, unlike mutual funds, which usually publish constituents quarterly.

Constituents of an Index are changed as and when the securities in the Index do not match the specific criteria laid down by the Index Service Provider or if a better security is available to replace a constituent. Once Securities in the underlying index are changed, the ETF will make a similar change in its portfolio. Index changes are usually not so frequent.

The chief distinguishing feature of ETFs is that it is passively managed. Essentially, passive management means the fund manager makes only minor, periodic adjustments to keep the fund in line with its index. This keeps management fees low and does away with the adverse consequences of failing to properly predict the future.

Sometimes the two are confused since they both sell on stock exchanges. An ETF follows a designated index or benchmark very closely and can grow or shrink with investor flows. A closed end fund tries to beat a target index by actively selecting individual stocks and may deviate significantly from the index. Closed end funds are closed to new money, so investors buy and sell shares on the open market. ETF management fees tend to be far cheaper.

Like ETFs, Index mutual funds also track baskets of securities. Unlike index funds, which are priced once after the end of each trading session, ETF prices change throughout the day because they're traded like shares.

Given the wide range of investment strategies ETFs allow, they are products both suitable for institutional and individual investors. Although being a passive management product, ETFs are frequently used at the same time as individual shares or investment funds. They are used for both for a long-term and short-term investment strategies for all kinds of investors.

All trades are generally guaranteed and the exchange auctions any shortfall in the units.

Yes, and this can either be a reinvestment or a cash distribution.

ETFs do this because it allows redemption and creation of units every day. This enables arbitrageurs to take advantage of any potential discount between the market price and its NAV.

They derive their liquidity through a process with the fund in creation unit size as well as from the units that are traded in the secondary market.

A smart beta fund would primarily provide alternatives to passive and active index investing and seek to provide superior risk-adjusted performance. On the other hand, an index fund constructs the index by using the market capitalization of component companies.

Its NAV is the total value at which each aspect of the fund’s assets amount to. Meanwhile the market price is simply the price of the shares when they can be purchased or sold.

When a plan is submitted to introduce a new ETF by a financial institution, it either gets approved or denied. Once it is approved, the ETF sells creation units made up of thousands of shares and those creation units are then traded for the same amounts represented by the ETF.

When a plan is submitted to introduce a new ETF by a financial institution, it either gets approved or denied. Once it is approved, the ETF sells creation units made up of thousands of shares and those creation units are then traded for the same amounts represented by the ETF.

You can check the NAV on the respective website after the market has closed and compare it with the ETF’s price. Very seldom are there any substantial differences between the two.

There is only one viable similarity between them and it is that their common objective is creating a profitable return on investment by being equity investments.

The Securities and Exchange Commission (SEC) enforces the regulations for the respective sales on the open market. The regulations are very strict and specific. The rules are with regard to the names of the funds, financial disclosure, sales materials, and fiduciary responsibilities.

It is a fund that is used to invest in a specific country.

It depends on the particular ETF although it usually available and can be sold short.

The market price of an ETF is essentially determined by the law of supply and demand within the market.

It always depends on the underlying commodity. If it is possible to access the relevant commodity, then yes, the respective ETF can track the spot price.

Yes, it is always possible for ETFs based on futures contracts to outperform the commodity spot prices.

A sales fee is charged by load funds whereas sales fees are not charged by no-load funds. Yes, it does affect your investment return. A load fund would reduce your investment return depending on what the sales fee or charge is.