An ETF is a financial product that replicates the performance of an asset or a set of them. It offers facilitated access to the investment market, allowing you not to directly purchase the asset in question.
ETF is the acronym for Exchange Traded Fund, a financial product listed on traditional markets.
ETFs are investment funds designed to replicate the performance of specific indices, sectors, commodities or other assets. They provide individual investors with access to broad sectors of the market or specific investment strategies, offering a way to invest without actually owning the asset of their interest.
Defined as a basket of securities, an ETF can include a wide variety of underlying assets, which can range from stocks, bonds, commodities to cryptocurrencies.
For example, an ETF that tracks the S&P 500 index is composed of the same stocks present in the latter.
Who manages an ETF?
ETFs are usually managed by financial institutions or wealth management companies, known as issuers. The issuing company is responsible for creating and managing the ETF, including the purchase and sale of securities in the ETF’s portfolio.
Their task is to ensure that the ETF follows its benchmark index as closely as possible.
While an investment company is responsible for managing the ETF, several financial intermediaries are involved in the creation, redemption, and negotiation process of an ETF.
Here are the main intermediaries involved:
- ETF issuer: The management company that creates the ETF and decides all its structure and functioning.
- Authorised Participant (AP): Usually large financial institutions, such as banks or other financial companies, that interact directly with the ETF issuer. APs play a crucial role in the creation and redemption process of the ETF shares to ensure that the ETF price remains aligned with its Net Asset Value (NAV).
- Custodian bank: The custodian bank is responsible for the safekeeping of the underlying assets of the ETF.
- Market maker: These are banks or authorized institutional entities, called “Specialists”, that have the responsibility of providing liquidity to the ETFs and constantly offering purchase and sale proposals, with precise quantity and price obligations that guarantee the efficiency of trades.
- Broker–dealer: This is the intermediary between buyers and sellers of ETFs on the secondary market. Investors buy and sell ETF shares on the stock market through broker-dealers.
- Clearing House (CH): The clearing house ensures that transactions are correctly processed between the buyer and the seller.
How to buy or sell an ETF?
ETFs can be bought and sold like normal shares through an online broker or a traditional broker: all it takes is placing a buy or sell order.
There are two main types of orders: a market order (spot) and a limit order (limit). A market order allows the ETF to be bought or sold at the current market price. A limit order allows the ETF to be bought or sold when it has reached the price set by the client.
How to verify the underlying asset?
Investors can verify the underlying assets of an ETF by examining its prospectus, which is a legal document detailing the investment objectives, composition, strategy and holdings of the ETF. The prospectus is usually available on the ETF promoter’s website.
Another option to check the underlying of an ETF is to check the fund factsheet: this is a one or two-page document providing a high-level summary of the ETF. It is easier to read than the prospectus, but may be less detailed.
How to replicate the performance of an asset?
The replication of an ETF’s underlying asset is managed in two ways:
- Physical replication: the ETF actually holds the underlying assets it is tracking. For example, an ETF that tracks a particular stock index will hold a selection of shares in that proportion, thus replicating the index. These ETFs are checked and measured based on net asset value (NAV) at the end of each trading day.
- Synthetic or indirect replication: some ETFs use derivative instruments (like contracts for difference or futures) to gain exposure to their underlying assets. These ETFs are known as synthetic ETFs. They enter into a swap agreement with another counterparty (usually a bank or another financial institution) which commits to paying the ETF the return of its benchmark index in exchange for the payment of a fee.
In both cases, the replication of an ETF’s underlying is overseen by various parties, including index providers, ETF providers, trustees, and auditors. They ensure that the ETF is properly executing the replication of its index or underlying asset.
What are the most popular ETFs?
There are ETFs for all asset-class categories: equity, bond, real estate, international, and sectoral.
An ETF’s popularity can vary based on various factors such as trading volume, past performance, portfolio diversification, and cost management.
Some of the most popular ETFs include the SPDR S&P 500 ETF (SPY), which follows the S&P 500 index, Invesco QQQ Trust Series which replicates the NASDAQ index, and Vanguard Total Stock Market ETF (VTI), which tracks the performance of the CRSP US Total Market Index.
The launch of gold ETFs
The introduction of gold ETFs has made it easier for investors to get exposure to the price of the metal, thereby increasing demand and also the price.
Since the approval of the first gold ETF, known as SPDR Gold Trust (GLD), launched in 2004, the price of gold has seen a strong increase.
From the price chart, it can be noticed that, in correspondence with the launch of the ETFs, the price of gold has increased significantly.
BlackRock’s proposal for a spot Bitcoin ETF
On June 15, 2023, BlackRock, the world’s largest asset management company, submitted a proposal to the Securities and Exchange Commission to issue a Bitcoin spot ETF.
According to the proposal, BlackRock would act as the issuer of the fund, while the bitcoins would be held by the Coinbase exchange, which would act as custodian.
At the moment, the proposal is awaiting approval by the US SEC. All specifications of the ETF are in the process of being defined and negotiated. Along with the one proposed by BlackRock, nine other Bitcoin spot ETFs are waiting to be approved.
