The ETF (acronimo di Exchange Traded Funds) they are one-of-a-kind investment funds, which work like mutual funds but are traded on the stock exchange like shares. By combining these qualities with limited expenses, by focusing on ETFs you obtain an investment that can be defined as “versatile” and which can be used by different types of investors, from beginners to expert professionals (always taking into consideration the fact that like any type of investment is not without risk).
An ETF can be structured to track anything from the price of a single commodity to a large, diversified basket of securities. ETFs can also be designed to follow specific investment strategies.
ETFs faithfully replicate the performance and therefore the return of stock, bond or commodity indices.
The first ETF was the SPDR S&P 500 ETF (SPY), which tracks the S&P 500 index and is still a popular ETF among traders and investors today. The regulated market managed by Borsa Italiana and dedicated to these instruments is called ETFplus.
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What are ETFs
An ETF, an acronym for “exchange-traded fund”, is an investment security that holds other investment assets, such as stocks or bonds.
Born in the USA in the early 1990s, ETFs arrived on the Italian market in September 2002 and have enjoyed growing success since then. In essence they represent a particular type of investment fund or Sicav which has two main characteristics: on the one hand the fund is traded on the stock exchange like a share, while on the other its investment purpose is to replicate the index at which it refers to (benchmark) through totally passive management.
What are the main characteristics of ETFs
Through ETFs, investors can easily gain exposure to a wide range of asset classes or strategies without having rights in the companies in which they invest.
Here are some of the main characteristics of ETFs.
Diversification: Nearly all ETFs offer diversification benefits over buying individual stocks. However, some ETFs are highly concentrated, both in the number of different securities they hold and in the weighting of those securities. For example, a fund that concentrates half of its assets in two or three holdings may offer less diversification than a fund with fewer total portfolio components but a broader distribution of assets. In essence, investing in an ETF means easily taking a position on an entire market index, which by referring to a large basket of securities, diversifies and reduces the risk of the investment;
Trading on the stock exchange: Being listed on the stock exchange, you can buy and sell shares as you would any other company, during market hours, meaning you can build and rebalance your portfolio relatively quickly and easily.
Transparency: by replicating a market index, with ETFs investors can identify the risk/return profile of their investment as well as the securities portfolio to which they are exposed. The price also updates in real time and, therefore, the investor is constantly updated on the value of his ETF investment.
Low costs: being passive management tools, ETFs do not have the typical costs of active management (team of analysts) and those linked to distribution. Each ETF is characterized by low Total Annual Commissions (TER) by virtue of totally passive management, paid in proportion to the holding period of the ETF and withheld daily, for the relevant portion, by the manager.
How ETFs work
But how do ETFs work? The mechanism can be summarized as follows: an ETF provider considers the universe of assets, including shares, bonds, raw materials or currencies, and creates a basket of them, with a single ticker. Investors can buy a share of that basket, just like shares of a company. The ETF allows you to obtain a return equal to that of the reference benchmark by virtue of “totally passive management”.
Unlike those who invest in shares, when you purchase an ETF, you do not own part of the assets, but the fund manager is always the owner and balances the number of securities present in the ETF to keep its price in line with its value. of the underlying assets or index.
How do ETFs make money for investors?
ETFs are exchange-traded funds and their prices fluctuate throughout the day, like stocks. They allow you to earn money by trading. Additionally, some ETFs pay out the money the ETF earns to investors. These payments are called distributions. For example, you may receive:
Interest distributions if the ETF invests in bonds Dividend distributions if the ETF invests in dividend-paying stocks Capital gains distributions if the ETF sells an investment at a higher price than an investment at a higher price than paid.
Unlike many mutual funds, ETFs do not reinvest cash distributions in other units or stocks.
What happens with distributions? There are two options: the money remains in the account until you tell your investment company how you want to invest it, in which case you may have to pay a sales commission on what you buy.
Or the investment company may offer a program to automatically buy additional ETF shares or shares, and you likely won’t pay a sales commission on these automatic purchases.
What are the risks of investing in ETFs?
The level of risk and return of a specific ETF depends on the type of fund and what it invests in. THE risks may include:
1. The trading price of units or shares may vary: Units or shares may trade in the market at a premium or discount to their net asset value (NAV), due to market supply and demand.
2. Concentration can lead to volatility: If an ETF is heavily invested in only a few investments or types of investments, it may exhibit some volatility over short periods of time compared to a more broadly diversified ETF.
3. Although an ETF is listed on the stock exchange, there is no guarantee that investors will purchase its units or shares. This means you may not be able to sell your ETF when you want to. An active market for the ETF may not develop or be maintained.
4. Some don’t have a benchmark: Some ETFs are index-linked, meaning it’s easier to track their performance than a benchmark. However, this does not apply to all ETFs. Active ETFs, for example, may not be designed to track an index, so it is difficult to compare performance over time.