Exchange Trade Funds Definition
An exchange-traded fund (ETF) is a financial investment vehicle that is traded on stock exchanges, like stocks. An ETF holds assets such as stocks, commodities, currencies or fixed income products and trades at approximately the same price as the NAV of its underlying assets during the trading day. Most ETFs track an index, such as the S&P 500 or Oil prices. ETFs may be attractive as investments because of their low costs, tax efficiency, and stock-like features.
An ETF is an actively traded financial instrument that is similar to a mutual fund in that it attempts to track the returns of an index, sector, commodity or currency. Closed-end funds, which specify the amount of capital they will hold in their fund, are not exchange traded funds. ETFs began trading in the United States in 1993 and in Europe in 1999. Exchange traded funds until 2008 where not actively managed by portfolio managers, and where initially created to follow another instrument.
Exchange traded funds have low cost structures which make them attractive relative to purchasing a basket of stock or commodities to mimic the return behavior. ETFs trade throughout a trading session, which provides robust liquidity, compared to mutual funds.
Index Fund
Most ETFs track a specific index or sector which hold securities and attempt to replicate the performance of an index. An index fund attempts to mimic the returns of by generating a portfolio that owns stock that makes up an index. Some index ETFs, known as leveraged ETFs or inverse ETFs, use investments in derivatives to seek a return that corresponds to a multiple of, or the inverse of, the daily performance of the index.
Index funds such as the Spider Select S&P 500 Fund (NYSE: SPY) are used for both speculation and hedging purposes. An index fund such as the SPY will follow the returns of the S&P 500 index and give an investor direct exposure to this large cap index.
Index ETFs are also tools that are used to hedge exposure to specific market indexes. Many investors will use liquid index ETFs to hedge a portion or their entire portfolio prior to an adverse market move. Investors will also look to mitigate volatility by shorting index ETFs, and protect their portfolio of stocks that track major indexes.
Popular Index ETFs:
- iShares Russell 2000 (NYSE:IWM) – This liquid index ETF’s follows a broad small cap index and provide superior liquidity for investors looking to generate exposure to the Russell Small Cap Index
- Nasdaq 100, PowerShares QQQ Trust (NYSE:QQQ) is the most liquid and well known gauges of the Nasdaq 100. This ETF is an excellent proxy for technology stocks and is used for both speculation and hedging.
- S&P 500 iShares Spider Select (NYSE:SPY) is the most liquid of the index funds, capturing the movements of the benchmark S&P 500 Index
- Diamonds iShares (NYSE:DIA) – is the most liquid of the index ETF’s the follow the Dow Industrial Index