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Education

Exchange Traded Fund Guide

Concept

ETFs represent a natural evolution of investing in shares and funds by combining the benefits of both.
Benefits of shares
Ease of clearing and settlement
Existing UK ETFs at the London Stock Exchange trade on SETS (stock exchange trading system) and settle in CREST electronically. There is no paper based certification or settlement - the whole process is \"dematerialised\".

Intra day trading during market hours
ETFs, like any share on the market, trade continuously throughout the day within market hours. This means that there is price transparency in real time and investors can see the value of their investments before, during and after any decision to trade.

Well regulated trading environment
ETFs trade on a stock exchange, this offers investors the comfort of a secure and orderly environment in which to conduct their investment transactions.

Available through any stockbroker
Like a share, ETFs can be bought or sold through any stockbroker allowing investors the choice of service they require (online / traditional / advisory / execution only).
Benefits of funds
Instant diversification
ETFs are collective investments and as such they represent immediate access to a diversified portfolio through the purchase of one single share. Broad market exposure reduces stock specific risk.

Active versus passive
Existing UK ETFs are passively managed which means that the stocks held within the fund are determined by an index. Therefore, the performance of the fund does not rely on the expertise or strategy of an individual manager.

Low cost
ETFs are pooled investment vehicles and therefore investors benefit from the economies of scale available to the entire scheme. Annual costs are in the region of 0.5%.
Benefits of ETFs
Open ended versus closed ended
Unit Trusts are open ended investments that are bought/sold direct with a Fund Manager.

Investment Trusts are closed ended investments that are bought/sold through a stockbroker.

  PRICE DEALING
UNIT TRUSTS Advantage
subscribers buy their units of the scheme assets at around the net asset value 		Disadvantage
historic pricing / paper processing / admin in hands of single counterparty / slow settlement
INVESTMENT TRUSTS Disadvantage
investors do not buy in or sell out at prices that directly reflect the value of the scheme assets due to premiums and discounts		Advantage
dealing and settlement are transparent, electronic and customer friendly - effectively they trade like stocks
ETFAdvantage
price always very close to NAV with tight spreads		Advantage
easy to deal just like a stock expect NO Stamp Duty

Exchange Traded Funds capture the benefits of both Unit Trusts and Investment Trusts (i.e. both efficient pricing and efficient dealing).

Primary versus secondary market
The exchange traded fund structure enables authorised participants in the ETF to create new units in the fund at NAV whenever they choose. This is done in large size, typically worth more than £1 million, with a Creation basket usually to satisfy demand. The equities within this basket are in the precise proportions of the existing holdings of the fund. New ETF units are thereby created and available to investors within the secondary market, which is the listed environment on the stock exchange. ETFs should trade at a price very close to their net asset value, because if a premium or discount were to be sustained, an arbitrage on the price Vs NAV would offer a risk-free profit to authorised participants. They would either create new units or redeem old units by the physical transfer of the underlying fund constituents.
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