* As of October 2006, there were 315 ETFs in the United
States, of which 309 were stock ETFs (www.ici.org).
* The number of ETFs on the market grew by 57 percent
for 10 months of 2006.
* ETFs are traded on the stock markets and not through
Exchange-traded funds (ETFs) are baskets of stocks or bonds that
track a broad-based index, sector of an index, or stocks in countries.
ETFs are similar to closed-end mutual funds in that investors buy
these listed shares on the stock exchanges. The predominant listings
are on the American Stock Exchange (AMEX). These shares
represent ownership in a portfolio of stocks or bonds that track a
broad index or sector indexes. Investors buy or sell these shares
through brokers just like they do with individual stocks. ETFs are
priced based on the types of securities that they hold in addition to
the supply of and demand for the shares. These shares can be sold
short or bought in margin accounts, and they can be traded using
market, limit, or stop orders.
The greatest competition to mutual funds has come from ETFs.
ETFs have become popular investment alternatives to mutual funds
for many investors who want diversification and low-cost investment
options. The typical costs charged to investors in equity ETFs
are 0.4 percent of assets annually compared with 1.4 percent of
assets for the average equity mutual funds, according to Standard
& Poor’s (Young, 2004, p. 124).
There are over 300 ETFs to choose from; this number has
grown significantly since the first ETF, the Standard & Poor’s (S&P)
Depository Receipts (known as Spiders) was introduced in 1993.
Table 16–1 lists a few of the many ETFs traded on the market.
Some of the more popular ETFs are the SPDRs (Spiders) that
track the S&P 500 Index; Diamonds, ticker symbol DIA, that track
the 30 stocks in the Dow Jones Industrial Average; and the Qubes,
ticker symbol QQQQ, that track ownership in the 100 largest stocks
on the Nasdaq. There are numerous ETFs that are specialized in
sectors of the broad indexes (financial, technology, and industrials,
for example) and in foreign stock market indexes [i Shares, which
tracks the Morgan Stanley Capital International indexes (MSCI) for
20 countries and many regional sectors around the world]. Visit the
AMEX Web site at www.amex.com for information on the various
ETFs listed. See Table 16–2 for a description of spiders, diamonds,
and the Nasdaq 100 tracking stock.
Nasdaq 100 Trust
iShares MSCI EAFE Index
BLDRS Asia 50 ADR
BLDRS Europe 100 ADR
iShares Lehman TIPS Bond
Financial Select Sector
iShares Russell 2000
iShares MSCI Spain
|S&P 500 Index (large-cap)|
Dow Jones Industrial Average
100 Largest stocks on Nasdaq
International index (large-cap)
Inflation government bonds
Financial stocks in S&P
Small-cap stocks in Russell
More About Spiders, Diamonds, and Nasdaq 100 ETFs
There is a family of ETFs that is based on the S&P 500 Index and its component
sectors, such as technology, energy, and financials, for example. The SPDR Trust
holds shares of all companies in the S&P 500 Index. The purchase of a single
share in this trust gives its owner a share of the 500 companies in the S&P 500
Index. Several select, specialized SPDRs allow investors to track, for example,
the financials in the S&P 500 Index or the 79 tech stocks in the S&P 500 Index.
Investors also can track the utilities, industrials, and five other sectors in the S&P
500 Index. These sector ETFs are traded just like the main SPDR (SPY).
The ETF that tracks the 30 stocks of the Dow Jones Industrial Average (DJIA) is
called a Diamond (DIA). The purchase of a single share in this fund gives its
owner a share of the 30 DJIA stocks.
The ETF that mirrors the 100 largest stocks in the Nasdaq is called a Qube
(QQQQ). The purchase of a single share in this ETF gives its owner a share of
these Nasdaq 100 stocks.
Following is a list of some of the features of these ETFs:
Trading. These ETFs are traded on the AMEX.
Approximate share price ratio. The values of shares of a Spider, Diamond, and
Qube ETF in relation to the respective indexes tracked are 1/10 the value of
the S&P 500 Index for 1 SPY share, 1/100 the value of the DJIA for 1 DIA
share, and 1/20 the value of the Nasdaq 100 Index for 1 QQQQ share.
Dividends. Dividends are paid quarterly (in January, April, July, and October)
Risks. The risk for these ETFs is the same as experienced by individual stocks,
namely, price fluctuations. There is also the additional risk that the fund
may not replicate the exact performance of the underlying index because of
expenses incurred by the fund.
Net asset value. The NAV per ETF is calculated at the close of each business
day. The value represents the market value of the stocks in the underlying
index, plus any accrued dividends and minus any expenses on a
Short selling. Investors can sell short these ETFs and on a downtick.
The description of the net asset value (NAV) implies that the
share price of an ETF can trade above or below its NAV. This discrepancy
generally will not occur because of the issuance by the
ETF of shares in kind. Whenever a discrepancy in price occurs and
an institutional investor wants to exploit this price differential
with large blocks of shares (a minimum of 50,000), the ETF trust
redeems the shares with the underlying stocks in the index rather
than paying cash. The institutional investor then sells the shares
of the underlying stocks in the index, not the shares of the ETF, to
realize the price discrepancy. This concept emphasizes the similarities
between open-end mutual funds and ETFs. An ETF buys and
sells shares and issues new shares when necessary. However, ETF
investors can buy or sell shares at any time during the day on the
stock exchanges, whereas transactions involving open-end mutual
funds take place only at the end of the day at the closing NAV
price. The major difference between an open-end mutual fund and
an ETF is that when shareholders in mutual funds sell their shares,
the mutual fund may have to sell securities to raise enough cash to
pay shareholders, resulting in capital gain or loss transactions.
With ETFs, traders buy the shares sold by investors, and this leaves
the portfolio intact.
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