What is an exchange traded fund? John Waggoner explains in his Feb. 12 column in USAToday, “What the heck are ETFs? It’s complicated.” Waggoner is USA TODAY’s investing columnist, and formerly was senior editor at The Independent Investor, then the nation’s third-largest investment advisory newsletter.
Waggoner says an exchange traded fund is like a cross between a mutual fund and a stock, but far more complicated. It is a portfolio of securities that trades on the stock exchanges. Most track a securities index like the Standard & Poor’s 500-stock index.
But there are important differences between traditional mutual funds and exchange traded funds. First, a traditional open-end mutual fund prices its shares ? i.e., can be bought and sold ? on a daily basis, while exchange traded funds can be bought and sold continuously. Second, unlike most funds, you can sell exchange traded funds short ? i.e., you can sell shares you don’t own, and buy them later at a lower price and keep the difference if you guessed right, or at a higher price if you guessed wrong.
Exchange traded funds are also like closed-end mutual funds in that both trade continuously on the stock exchanges. But, Waggoner warns, closed-end funds are plagued by pricing anomalies: Very often, a closed-end fund’s share price is higher than the actual value of its holdings ? i.e., they can trade at a discount or a premium relative to their holdings.
Exchange traded funds reduce the premiums and discounts that closed-end funds often have by allowing very large investors to trade big blocks of an exchange traded fund’s shares ? typically 50,000 shares or so ? for the underlying securities in the ETF. Waggoner says that these big block trades happen when the cost of the ETF shares is less than the underlying stocks in the ETF, and the net effect is to bring the ETF share price back in line with the underlying securities.
The benefits of exchange traded funds include low cost, tax efficiency and diversity of investments, while the negatives include the fact that most firms charge a commission to buy or sell an exchange traded fund, and some exchange traded funds track lesser-known and rarely-followed indexes with little or no track record.
Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 30 occasions. Page Perry’s attorneys are actively involved in representing institutional and corporate investors in exchange traded fund cases. For further information, please contact us.