Saturday, June 7, 2014

Exchange Traded Funds

Some months ago I came across a news article discussing the first exchange-traded funds (ETFs) available to local investors.  At the time I wasn't actively blogging (or even investing) so I didn't take too much notice.  I think now would be a good time to educate myself by reading up on ETFs and writing a blog post.

From Investopedia:
A security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. ETFs experience price changes throughout the day as they are bought and sold.
Much like a mutual fund or a UITF an ETF pools investors' money and invests it in assets such as stocks or bonds.  The main difference is that ETF shares (or units) may be bought or sold throughout the day on an exchange (such as the Philippine Stock Exchange).

The ETF share price behaves just like other stock prices, varying as they are bought and sold.  Thus investors are able to buy and sell shares at prices other than the NAVPS, unlike mutual funds and UITFs.  However, investors pay broker's fees for every trade (purchase or sale) of ETF shares.

Investors in ETFs may also use the same strategies stock traders do, such as short-selling and margin trading (see notes below), along with all the potential rewards and risks of those strategies.

Since ETFs track indices (such as the PSEI), the fund itself doesn't need to buy or sell assets often, unless the composition of the index changes.  Theoretically, this should translate to lower operational costs and lower fees for investors.

So, the most important question:  who should invest in ETFs?

Investors who:
  • want the advantages of index funds (post to come later)
  • want the flexibility of being able to sell ETF shares like stocks (more at Stocks vs. Equity Funds)
  • don't plan on cost-averaging with small amounts.  Broker's fees will quickly eat into smaller investment amounts 
That's it for this now.  In the next post, we'll take a look at First Metro's ETF.

Update:  Post about First Metro Philippine Equity ETF is now up.

Notes: 

Short-selling: selling shares not owned by the seller.
Margin trading: borrowing money from a broker to purchase shares.

More at Investopedia:

ETFs
Short-selling
Margin-trading


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