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Exchange-Traded Funds (ETFs) are exciting new investment tools that have grown rapidly to over $400 billion of assets. ETFs offer exposure to dozens of asset classes due to ETFs broad diversification, great flexibility, low expense ratios, high tax efficiency, superior ETF trading flexibility, and competitive long-term performance versus active managers.
ETFs are passively managed portfolios designed to track specific indexes and represent baskets of stocks, currencies or commodities.
Some ETFs offer relatively low-risk, broadly diversified portfolios, which investors may find attractive as the core equity components of their portfolios. Others offer diversified investments in particular styles, sectors, industries, regions, countries, or commodities.
There are currently almost 300 ETFs that provide exposure to US equity markets.
The largest ETF managers include Barclays Global Investors (iShares), State Street Global Advisors (street TRACKs and SPDRs), Bank of New York (QQQQ), MDY, BLDRs), Vanguard, Merrill Lynch (HOLDRs), World Gold Trust, PowerShares, Rydex, ProShares, WisdomTree, DB Commodity Services, Victoria Bay, Van Eck, Claymore, First Trust, and Fidelity. Several ETFs offer exposure to duplicate or similar indexes; however, there are significant differences in the products and indexes especially as to how they weight companies in the ETF basket. We believe investors should favor ETFs that best meet their investment objectives with the lowest operating expenses and reasonable liquidity.
There are 80 ETFs that provide international equity exposure.
Many international ETFs are iShares based on MSCI Indexes, but others are based on S&P, Bank of New York ADR, Dow Jones STOXX, and WisdomTree indexes.
ETFs are an excellent tool to build a low cost and simple global portfolio. ETFs offer investors have many choices of global and international sector ETFs to allow them to take advantage of global growth and value opportunities around the world.
Six ETFs offer US fixed-income exposure.
They are all iShares based on Lehman Treasury and Aggregate Indexes and a Goldman Sachs Corporate Bond Index. There are also ETFs that target dividend rich companies and preferred stock.
There are 14 ETFs that provide exposure to alternative asset classes including gold, silver, oil, broad based commodities and currencies.
Three commodity ETFs hold the physical commodity in which they invest, while three other ETFs utilize commodity futures. The currency ETFs invest in foreign time deposits or currency futures.
ETFs trade on major exchanges.
This allows investors to buy and sell them at stated market prices. In contrast to open-end funds that price once a day at the close, ETFs are available to all investors at market prices throughout the day. This helps to reduce the uncertainty of buying shares intraday at prices to be determined at the close. Many index-linked ETFs can also be shorted without an uptick, providing extra flexibility for hedging or market-timing.
ETFs are very flexible investment tools relative to mutual funds.
They can be bought on margin, purchased using limit and stop loss orders, and many have listed options. This open trading prevents opportunities for market timing in which some investors buy open-end funds investing in foreign markets that closed before US trading started. For example, on a day when the US market is higher, ETFs based on a Japan index usually trade up in anticipation of higher prices in Japan overnight. In this case, open-end funds investing in Japan may be priced based on the previous day’s close.
Index-linked ETFs have some of the lowest expenses of any investment tool.
Their expense ratios are significantly lower than those of open-end mutual funds, but the range has widened as some providers cut fees while certain newer products have higher fees. For example, the Vanguard Total Stock Market Index Fund (VTI) has an expense ratio of seven basis points (bps), while the average actively managed domestic equity open-end fund has 150 bps in expenses.
ETFs are also tax efficient since the securities in the ETF basket only change as the index it tracks change.
Mutual funds often distribute large amounts of capital gains to shareholders each year. ETFs capital gains distributions are rare and so ETF investors enjoy a lower tax burden which of course drags down returns.
For a complete list of ETFs, ETF sponsor information, articles about ETFs and performance data, please go to ETF Library.
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