We tell you the basic principles of investing in ETF.
ETF (Exchange Traded Funds, exchange traded fund) is an exchange-traded fund, which invests in certain groups of assets. The mechanism of the ETF is quite simple. Company (ETF Issuer) has a specific asset (for example, stocks from the index or gold) and on this asset issues securities, the dynamics of the price of which depends on the dynamics of the price of the underlying asset.
ETFs as an exchange instrument originated in the late 70s. Then the first ETF was released by The Vanguard Group.. But ETFs gained their popularity only in the 90s.. Now it is one of the most rapidly developing tools.. According to the latest ETF Global data, more than half of all ETFs are in the US market. It is there that the headquarters of the largest issuers are located.: State Street Global Advisers, BlackRock Inc, The Vanguard Group.
ETF types
ETFs can be classified by asset type, on which they are released. ETF allows you to invest in:
• Country stock markets
• Selected sectors of the economy
• Currencies
• Indices
• Eurobonds
• Commodities (gold, oil, silver, etc.)
• other assets.
There are a number of ETFs with a more complex governance structure.. Such ETFs are called exotic or specific. Among them are the:
• Inverted or reverse ETFs – the price dynamics of such ETFs are inversely proportional to the price of the underlying asset. Such ETFs, simply put,, "short" the underlying asset.
• Margin ETFs are the opposite of reversible ETFs, they use the long position mechanism, to show greater profitability, than the underlying asset. For example, when the price of the underlying asset rises by 1%, the price of etfs will increase by 2%.
• Volatility ETFs (BARELY) — ETF, which is based on the volatility index or, what is it also called, fear index.
Pricing mechanism
The share price of the index fund will repeat the dynamics of asset prices, which are the basis of the fund.
The price of one share of the fund is the value of the fund's net assets, attributable per share. It's calculated. (fair) share price is a kind of ETF price benchmark. The estimated price of the fund's shares is published on the website of the fund or news agencies.
At the same time, the market price of the fund's shares on the stock exchange may differ from the estimated price of the fund's shares on the stock exchange.. This can be influenced by many factors.: exchange rate, difference between supply and demand. So that the market price on the exchange is as close as possible to the settlement price, except for ordinary buyers and sellers, there are market makers on the stock exchange - they put prices, close to "fair", that is, calculated. The market maker must participate in the auction at least 7 hours during the day. In this way, the price of the fund's share on the stock exchange tends to settlement.
Features of working with ETFs
AN ETF is an exchange instrument, shares of which can be very easy to buy. ETF liquidity is quite high, therefore, you can buy and sell shares of the fund at any time during the trading session. To do this, you need a regular brokerage account or IIS (to work with ETFs on Russian exchanges).
The largest number of ETFs are traded on the site NYSE Arca. This platform is not available for trading to unqualified clients. The Central Bank of the Russian Federation does not classify part of foreign ETFs (for example, on volatility) like securities, therefore, at the moment there is no possibility to buy them on a Russian brokerage account.
Many ETFs, among other things, pay dividends to holders of their shares. Dividends provide investors with regular income, which can be further reinvested in new assets, put in storage or spend at your discretion. Dividend income from ETFs is different from that, which is paid on shares. The underlying asset on etfs can be hundreds of shares, for each of which dividends are paid. On ETFs, dividends are calculated and distributed on a pro ra rake basis.. The disadvantage of such a system may be the fact, that the dividend yield rate can change frequently. On the other hand, dividends come from a diversified group of shares, which reduces risk and can bring greater returns.
Another feature, which is worth paying attention to is the commission for managing the fund. However, this is not the same commission., which is charged broker or exchange, and it is not charged additionally. This commission is already included in the cost of the fund. All ETFs (as well as mutual funds) charge their shareholders a fee for the management of the fund (Expense rates). The issuer of the fund has operating expenses throughout the ETF (taxes, administrative expenses, marketing, etc.). This commission is expressed as a percentage of the fund's average net assets..
Investment risks
Firstly, you may encounter the fact that the ETF price lags behind the price dynamics of the underlying asset, however, in some cases, this can play into the hands of. For example, when, if there has been a correction in the market, you can have time to get out of the position, until your ETF follows down the underlying asset.
Secondly, if you work with complex ETFs, there may be a need for additional analysis of the structure and risks of this instrument. For example, before buying a reverse ETF, it is necessary to analyze the size of the leverage and the correspondence to the price dynamics of the underlying asset.
Thirdly, there is a risk of closing the country index for the relevant ETFs. The predominant number of ETFs in the world are issued for shares, or rather on indices, e.g. S&P 500. But not all ETFs are tied to known indices., since the maintenance of such indices is expensive. Therefore, little-known indexes are most often used to create ETFs..
Fourth, do not forget about the risk of delisting the instrument.
The reasons, for which ETFs should be considered
Relatively low cost. This tool allows you to invest small money in large companies. If you buy the same shares directly, then you will have to invest more. For example, Apple and Facebook shares are worth hundreds of dollars, and some ETFs are many times cheaper, although includes shares and Apple, и Facebook.
Diversification. ETFs allow you to invest money not only in individual companies, but also to entire industries, countries or markets, which significantly reduces the risk of losing money.
Liquidity. ETFs can be quickly sold or bought.
Transparency. The structure and other information about the ETF is publicly available and can be viewed by any investor.
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