WHAT IS AN ETF?
An authorised index tracking exchange traded fund (ETF) is a fund that is traded on an exchange. Its principal objective is to track, replicate or correspond to the performance of an underlying index. The index can be on a stock market, a specific segment of a stock market or a group of stock markets in a region or elsewhere in the world. It can also be on bonds or commodities.
An ETF gives investors an indirect access to a certain market. By investing in an ETF, investors can receive a return that replicates (although not 100% in most cases) the performance of the index without actually owning the constituents that comprise the index. In some cases, an ETF tracks an index of a market that has restricted access (such as, the China A-share market or the Indian market), thus giving investors indirect access to a market that is not accessible by foreign investors not domiciled in that jurisdiction.
ETFs are passively managed funds which aim to track closely the performance of the underlying benchmarks.
Each ETF has its own website operated by its ETF manager. ETFs’ websites provide key information such as the underlying benchmarks and the benchmarks’ constituents, the ETF’s Net Asset Value (NAV), the counterparty exposure and details of collateral from counterparties. The NAV of an ETF is the sum of marked-to-market values of the individual portfolio holdings plus the portion of the assets held in cash and cash equivalents, less all the accrued ETF expenses. The NAVs of ETFs are calculated intra-day during the trading hours and at the end of the trading day. The intra-day estimated NAVs, or iNAVs, are also known as RUPVs (Reference Underlying Portfolio Value) or IOPVs (Indicative Optimised Portfolio Value). The end-of-day NAV information may also be obtained on the ETF’s website. Real-time or delayed price quotes for ETFs are disseminated by information vendors and are available on the relevant exchange website.
Low transaction costs
Unlike unlisted funds, ETFs are subject to a low total annual commission (TER) applied automatically in proportion to the holding period, whilst the investor is charged no “Entry”, “Exit” and “Performance” fees. The transaction costs for trading ETFs are the same as those for trading other securities, which include brokerage commission, transaction levy, trading fee, etc.
Low minimum investment
ETFs are traded in board lots and the minimum initial investment is usually set at an affordable level. Liquidity ETFs can be traded any time during the trading hours of the securities market. Listed ETFs usually have market makers, which are known as Securities Market Makers, to provide some liquidity. However, market making for the ETFs is available only during the Continuous Trading Session. The list of market makers for each ETF as well as their contact details are published on relevant exchange website.
ETFs are traded through brokers in the same way as other securities and the settlement arrangements are the same. Diversification Most ETFs track a portfolio of assets to provide diversified exposure to selected market themes. However, ETFs may also track a single underlying asset such as gold. Market exposure While some ETFs provide Hong Kong investors access to a basket of Hong Kong securities, others provide the investors access to overseas markets or other asset classes.
Most ETFs track a portfolio of assets to provide diversified exposure to selected market themes. However, ETFs may also track a single underlying asset such as gold.
While some ETFs provide local investors access to a basket of local securities, others provide the investors access to overseas markets or other asset classes.
WHERE CAN I BUY OR SELL ETFS?
You can buy or sell ETFs through your broker the same way as you buy or sell other securities. There is no need to open a separate trading account for ETFs.
HOW DOES AN ETF TRACK THE PERFORMANCE OF ITS UNDERLYING INDEX?
Tracking is usually achieved by using full replication or representative sampling, or synthetic replication strategies.
- Using a full replication strategy means that an ETF will invest in the constituent securities of the underlying index in substantially the same weightings as these securities have in the index. Hence, the performance of the ETF will match the performance of the underlying index as closely as practicable.
- An ETF adopting a representative sampling strategy holds a sample of securities that have similar features such as market capitalisation, industry weights and liquidity to the constituent securities of the underlying index. ETFs that use this strategy tend to have a higher risk of tracking error than those using a replication strategy.
- A synthetic replication strategy means that the ETF will invest in financial derivative instruments to replicate the index performance. There are additional risks associated with such strategy that are not found in the above two strategies.
WHAT ADVANTAGES DO ETFS BRING TO INVESTORS?
- ETFs provide opportunities for investors to achieve instant, efficient exposure to different asset classes and obtain a broad diversification with one single purchase transaction;
- ETFs are passively managed, which means they have relatively low management fees reducing the costs of one’s own portfolio;
- ETFs are listed on the exchange, so they can be bought and sold on the exchange at any time during a trading day and at current market prices;