What Looks Like A Mutual Fund But Trades On An Exchange?

Did you know that you can buy and sell exchange traded funds (ETFs) at Motif Investing, either on a standalone basis or within motifs?

ETFs are structured like mutual funds but trade on stock exchanges and tend to have much lower fees. An ETF tracks an index, commodity, bonds, or basket of assets.

A Brief History Of ETFs

State Street Global Advisors issued the first ETF (in the form we know of them today) back in January 1993: the Standard & Poor’s Depositary Receipt (more commonly known as Spiders since the acronym for it is SPDR). Since then it has grown to over $123 billion in assets, becoming the world’s largest ETF. It also accounts for over 16 percent of all ETF assets in the U.S.

ETFs have grown more than sixfold in the last decade. In 2005, all ETFs combined totaled around $3 billion in assets. By 2014, there were over 1,500 ETFs traded in the U.S., with a total market of about $2 trillion.

Source: Bloomberg Markets

In recent years, a subcategory called smart-beta ETFs has emerged. They are designed to be managed entirely by machines, although in actuality humans create the rules that the programs are based on.

Unlike traditional ETFs that use indexes based on market capitalization, geography or industry, smart-beta ETFs compile indexes using other data, such as book value, dividends, and revenue.

They are growing in popularity, but some investors remain skeptical of their viability. Examples of smart-beta laggards that have underperformed market indexes can be seen below.

Source: Bloomberg Markets

Some 52 entities issue ETFs, according to the Investment Company Institute. These issuers include a variety of financial institutions, some of them also issuing mutual funds or having other diversified bank or brokerage lines of business.

Benefits Of ETFs

Many investors like to trade ETFs for several reasons other than their performance potential. Here are some of the benefits.

1. Lower Barriers to Entry

Since ETFs are publicly traded, they are easily accessible to investors of all experience levels. They can be bought and sold just as easily as stocks. In addition, ETFs can be sold short and traded on margin as well.

2. Diversification

ETFs can help make it easier for investors to gain exposure to multiple markets and strategies. Investors have a wide range of ETFs to choose from including those that cover indices in specific countries, industries, and asset classes.

3. Cost and Tax Efficiencies

The fee and commission structure of ETFs can vary, but nearly all of them have lower fees than mutual funds. And because the management of an ETF does not involve trading stocks, there are fewer capital gains than actively managed mutual funds—which means less taxes for investors.

4. Risks to Note

Of course, any investment opportunity involves some degree of risk, and that includes ETFs.

For starters, there can be significantly varying degrees of market risk. This is largely dependent on which securities are in the ETF. Closely examine the ETF’s prospectus to determine whether the securities that make up the fund are compatible with your risk tolerance.

Investors should also be aware that there are large variances in quality and performance in ETFs, including those in the same genre or from the same issuer.

Another risk has to do with the category of ETFs that include futures or leveraged positions—they are often recommended for professional investors or those who have the ability to monitor their investments throughout the day. Perform due diligence before diving into any such complex strategy.

Although ETFs are popular, up to 100 are discontinued annually. To minimize your exposure to this risk, pay attention to the total amount of assets in any ETF you are considering—a small amount could be cause for concern. And if you learn that an ETF you already own might close, know that you may have to wait quite a while for the fund to complete liquidation and send you your money, so unwinding the position before the closure date might save you time.

Both new and well-established ETFs can also be susceptible to liquidity issues and varying transaction costs. Performance can be negatively affected if there are liquidity limitations.

Make it a habit to carefully weigh the risks and benefits before investing.