Exchange trade funds are investments funds which are traded on stock exchanges. Exchange trade funds hold things such as bonds, commodities, and stocks close to the net asset value during the trading day. Many exchange trade funds track an index much like the S & P 500. Exchange trade funds are generally low in cost, very tax efficient, and boast features like a stock. These are the most popular of the exchange-traded products.
In order to buy or share any shares of an exchange trade fund from the fund manager or to the fund manager, you must be an authorized participant. Generally those considered authorized participants are institutional investors. Shares of exchange trade funds are generally traded only in creation units. Creation units are considered blocks of at least ten thousand exchange trade funds shares. These creation units are typically exchanged in-kind with underlying securities. While participants are allowed long-term investments in exchange trade fund shares, they usually only act as market makers because of their ability to exchange larger unites with securities, which together provide liquidity for the exchange trade funds shares. This also ensures an intraday market price which is close to the net asset value for the underlying assets. Individuals who use a retail broker will generally trade exchange trade fund shares on the secondary market.
An exchange trade fund takes the valuation feature known to mutual funds or to unit investment trusts and combines it with the tradability features of closed-end funds. The former can be bought or sold for the net asset value at the end of each trading day while the latter can be traded throughout the entire trading day for a price which might be more or might be less than the net asset value. However, it should be noted that closed-end funds are not considered the same as exchange trade funds despite both being funds which are traded on an exchange. Since the year 1993 exchange trade funds have been available through the United States. They were available throughout Europe since the year 1999. Exchange trade funds were traditionally index funds. As of the year 2008, actively managed exchange trade funds were authorized by the U.S. Securities and Exchange Commission.
Historically speaking, in 1989 the S & P 500 had created a proxy known as the Index Participation Shares. These traded on the Philadelphia Stock Exchange as well as the American Stock Exchange. Soon after, the Chicago Mercantile Exchange filed a lawsuit which stopped the sales within the United States. The Toronto Index Participation Shares were similarly traded on the Toronto Stock Exchange by the year 1990. These shares were very popular and as such, the American Stock Exchange took notice and began developing something which would fit within the regulations of the SEC in the United States but was similar. It was Nathan Most alongside Steven Bloom who are attributed with the design and development, as well as exchange of the Standard & Poor’s Depositary Receipts. These were introduced in the United States in 1993 and become known as spiders. This quickly parlayed into the largest exchange trade fund in the world.
The use of exchange trade funds for investment purposes is beneficial in that they provide easy diversification alongside a low expense ratio and tax efficiency. They also maintain the same features as a stock such as options, short selling, and limit orders. There are a handful of types of exchange trade funds. The first are index exchange trade funds. Most fall under this category. There are also commodity exchange trade funds for futures and precious metals. Other options include bond exchange trade funds and currency exchange trade funds. There are also actively managed exchange trade funds available, exchange-traded grantor trusts, and leveraged exchange trade funds.
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