Frequently Asked Questions about Exchange-Traded Funds

By Sree Vidya Bhaktavatsalam

1. What is an exchange-traded fund?

An exchange-traded fund, or ETF, is an investment product representing a basket of securities that track an index such as the Standard & Poor’s 500 Index. ETFs, which are available to individual investors only through brokers, trade like stocks on an exchange.

2. How does an ETF differ from an index mutual fund?

Index mutual funds also track baskets of securities. Unlike index funds, which are priced once after the end of each trading session, ETF prices change throughout the day because they’re traded like shares. Like shares, they can also be sold short — a bet that the index value will decline — and bought on margin.

3. What are the advantages and disadvantages of ETFs versus mutual funds?

Exchange-traded funds charge lower fees than actively managed mutual funds and offer investors a wide range of sectors, geographies and strategies. Investors in ETFs pay average annual expenses of $36 for every $10,000 of assets, compared with $147 for actively managed U.S. stock funds, according to Morningstar Inc. in Chicago. Investors pay a brokerage fee when they buy or sell ETFs, a drawback for active traders. Commissions range from $4 to $25 a trade.

4. How do investors use ETFs?

ETFs are popular among institutional investors to make rapid and large bets on sectors as diverse and specific as oil, gold, waste-management and semiconductors. They also use ETFs to hedge their bets on stocks, bonds, commodities and other securities. For individual investors, ETFs offer a wider selection of indexes than mutual funds.

5. How much is invested in ETFs?

Assets in exchange-traded funds more than quadrupled in the past five years to $350 billion as of Sept. 30, 2006, according to Washington-based trade group Investment Company Institute. ETF assets will probably rise fourfold to $1.4 trillion by 2011, according to estimates by Financial Research Corp. of Boston.

6. Who are the major sellers of ETFs?

Barclays Global Investors, the asset-management unit of Barclays Plc in London, is the biggest seller of exchange-traded funds, with a 59 percent share of U.S. ETF assets as of September 2006, according to State Street Corp., which tracks ETF flows. Barclays manages about $214 billion in ETF assets. State Street, based in Boston, is the second biggest seller of ETFs, with about $91 billion in such assets.

7. What are some of the biggest ETFs?

The three biggest exchange-traded funds as of September 2006 were the $57 billion S&P 500 SPDR, managed by State Street; the $31 billion iShares MSCI EAFE, managed by Barclays; and the $18 billion Nasdaq-100 Trust, managed by Bank of New York Co., according to data compiled by State Street.

Copyright Fund China 2009.

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