By Lawrence Carrel April 15, 2013
Exchange-traded funds, or ETFs, are one of the fastest growing investment vehicles in the world today, and most financial publications cover them in one way or another.
ETF stories primarily fall into two categories: articles that address issues affecting participants in the ETF industry and personal finance stories for investors and advisors. Industry-focused stories are typically features dealing with new entrants into the industry, issues with trading, bid-ask spreads and liquidity, as well as breaking news. Personal finance stories examine the structure, holdings and costs of the funds and whether they make good investments.
The ETF industry started on January 29, 1993, with the creation of a single fund, the SPDR S&P 500 (ticker symbol: SPY), a joint effort of the American Stock Exchange and State Street Global Advisors. By the end of 2012, there were 1,194 U.S.-listed ETFs with assets under management of more than $1.34 trillion. The ETF industry has spread to many other countries, but ETFs outside the U.S. can have many differences from U.S. ETFs. This story will focus solely on ETFs listed in the U.S.
Exchange-traded funds are investment companies that trade like stocks but whose value reflects a basket of securities. Like mutual funds, they provide investors holding limited capital a way to own a diversified portfolio. ETFs are among the securities regulated by the U.S. Investment Company Act of 1940, better known as the 1940 Act..
Mutual funds and most ETFs are open-ended funds, which means that they can create as many shares as needed to fill investor demand. Mutual fund investors must place a buy or sell order during market hours, but the funds trade once a day, after the market closes, at just one price. ETFs trade on a stock exchange during market hours and fluctuate in price. ETFs can hold stocks and/or bonds and can be structured as either open-ended funds or unit investment trusts.
A major difference between ETFs and mutual funds is the way they are sold. Mutual funds sell shares directly to investors. ETF shares go through what is known as the “creation and redemption process,” in which actual securities are taken off the market and traded for an equal number of shares in the ETF. The securities are deposited and become assets of the fund, while the ETF shares are sold on the exchange to investors.
The creation/redemption process is what allows ETF shares to trade on an exchange while closely tracking the value of the underlying assets held by the fund. It’s also responsible for many of the benefits the ETF holds over the mutual fund, such as its flexibility, tax efficiency and transparency.
Strictly speaking, not all “ETFs” are exchange-traded funds. In addition to stocks and bonds, the creation/redemption process provides a way for alternative asset classes, such as commodities and currencies, to exist in an exchange-traded product (ETP) similar to exchange-traded funds.
Because most of the investing public remains unfamiliar with ETFs, the ETF industry refers to most of these exchange-traded products as ETFs as a way to avoid confusion. However, exchange-traded commodities and other ETPs, such as exchange-traded notes (ETNs), are not regulated by the 1940 Act. They have different product structures, hold different assets such as physical commodities, futures contracts or senior subordinated debt, and are regulated by other U.S. securities laws, giving them different tax structures. Most are not eligible for the low tax rate given to long-term capital gains.
Your job as the writer of a personal finance story is to give your reader all the information necessary to make an informed investment decision. Most ETFs are index funds, which means they try to replicate the return of a specific market index. You need to explain how the index is formulated and whether the ETF holds every security in the index or tries to approximate the index by holding only some of its components. You need to list the fund’s major holdings, and, if it’s an international fund, which countries it tracks. If the ETF isn’t new, give its 1-year, 3-year and 5-year performance record. Don’t forget to include the expense ratio, the fee the fund company charges for managing the ETF.
If you are writing about an ETP, in addition to the holdings, describe the product structure and tax structure. Finally, specify the risks that come with owning this kind of product. Remember, you are not selling the product. You are performing a service. Your job is to explain the product’s good and bad points.
Every major financial news organization reports on ETFs. However, IndexUniverse.com is probably the premier news source for the industry because it writes solely about exchange-traded products and indexes. ETFGuide.com is another good source.
Your first source for industry statistics and research is the Investment Company Institute, or ICI, the trade group for the mutual fund and ETF industries. The ICI has a list of all the ETF companies operating in the U.S. Introduce yourself to their media contacts and ask to receive their press release emails.
Every ETF company runs a website filled with extensive data about each of their funds. This should be the first place you look for information on a specific fund. Morningstar.com is an excellent source for up-to-date ETF performance data. Morningstar also publishes articles and analysis on specific funds and industry trends.
The ETF industry hosts conferences throughout the year. These are good places to meet industry leaders from the top fund companies, ETF analysts and investment advisors who use ETFs in client portfolios. In addition, as with most beats, call the sources other reporters use in their stories.
Lawrence Carrel is the author of “ETFs for the Long Run: What They Are, How They Work, and Simple Strategies for Successful Long-Term Investing” and “Dividend Stocks for Dummies.” He created the “ETF Focus” column for SmartMoney.com, wrote the weekly ETF column at TheStreet.com, and was one of the original writers of the Cyber Investing column at WSJ.com.
This entry was posted on Monday, April 15th, 2013 at 5:40 am. It is filed under On the Beat and tagged with ETFs, funds, investors, stock market, stocks. You can follow any responses to this entry through the RSS 2.0 feed.
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