Exchange Traded Funds


Exchange Traded Funds

Exchange Traded Funds (ETFs)

ETFs are typically portfolios of stock which track an index and trade throughout the day.

  • They are like open-ended mutual funds, which have replaced active management with a strategy of passively matching an index’s returns.

  • For example, the ticker SPY is for an ETF which matches the return (prior to fees) on the S&P 500 index. Because the fund is passively managed, fees are usually very low at around 0.10% of assets per year.

ETF Popularity and Growth

ETFs have become very popular in the last decade. Among their advantages over traditional mutual funds are:

  • ETFs can be traded throughout the day, and may be shorted and bought on margin. The cost of buying an ETF is the same as stock.
  • Selling an ETF doesn’t cause fund redemptions – which can have adverse tax consequences.
  • Fund redemption fees are charges made typically by mutual fund companies to discourage investors from making short term trades
  • ETFs have low fees – many prominent ETFs have annual fees that are less than 0.15% of assets.
  • Actively managed mutual funds have generally been unable to beat stock index returns.

Below is unscientific evidence of the increasing popularity of ETFs relative to mutual funds: The number of Google searches for each term. Click and drag on graph to zoom into selected time period. Double click to return to full view

New ETFs

While the first ETFs were mainly for broad stock indexes (the NASDAQ 100, S&P 500, and the Dow Jones Industrial Average, as a few examples), their rising popularity of has spurred the creation of ETFs for a variety of underlying assets, such as the following:

  • Stock sectors: Financials, Energy, etc.
  • Commodities: Crude Oil, Gold, Natural Gas, among others
  • Non-Stock Indexes: the VIX volatility index
  • ‘Actively managed’ ETFs
  • Leveraged ETFs

How Well Do ETFs Track Their Underlying Index?

The next slide will show you the cumulative returns for the ETF and index you choose.

  • Generally, for the established stock index ETFs, the ETF tracks the index very closely.

  • However, because there are many new and often exotic ETFs introduced each year, one can’t make a blanket statement across all ETFs.

ETF Performance

As you can see, the difference in cumulative returns between the ETF and the actual stock index over 10 years is generally less than a percent.

In summary, these ETFs do a good job of matching index performance.

ETFs versus ETNs

  • Exchange Traded Notes (ETNs) are unsecured debt obligations of financial institutions.
  • ETNs are also traded on securities exchanges and can be bought or sold on the exchanges.
  • ETNs unlike ETFs do not own a portfolio of underlying assets. ETNs calculate the value using a described formula, rather than using net asset value.

Credits and Collaboration

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