An Exchange Traded Fund ("ETF") is an investment
vehicle that, in its typical form, is designed to enable investors
to track a particular index through a single liquid instrument that
can be purchased or sold on a stock exchange.
An ETF offers characteristics of an investment fund (such as low
costs and broad diversification) but also characteristics more
commonly associated with equities (such as access to real time
pricing and trading).
ETFs have seen dramatic growth in recent years, in terms of
assets invested and the number of products available, in contrast
with the net outflows being currently experienced by many
traditional investment funds. The scope of the products on offer
has also widened with ETFs covering a broad range of asset classes
as well as specific sectors.
Set out below is a summary of some of the main advantages that
ETFs offer to investors, a brief overview of how an ETF is
structured as well as how ETFs can be established in Ireland within
the UCITS framework.
What is an ETF?
An ETF is a particular type of investment fund structured to
facilitate trading of its shares on an exchange. ETFs generally
function as index tracking funds, i.e. they provide their investors
with an exposure to the securities in an index. The listing on an
exchange means the ETF shares can be bought and sold by investors -
on an intra-day basis and using realtime pricing - much like an
Advantages of an ETF
Some of the particular aspects of ETFs that make them an
attractive investment for a broad range of investors are outlined
In almost all circumstances, an ETF will not be required to sell
securities within its portfolio, nor will it typically be required
to purchase such securities directly on the open market, due to the
in kind subscription and redemption arrangements regarding creation
units, discussed further under "ETF construction",
The decreased level of portfolio transactions means that the ETF
is subject to lower transaction costs than a traditional index
tracking fund, in addition to the generally lower management costs
of pursuing an index tracking strategy when compared with an
actively managed fund.
As a result, ETFs offer a lower cost alternative to other
investment funds where the average expense ratio of an ETF might be
0.25 per cent for an ETF compared to 1.5 per cent for an actively
managed fund. However, transactions in ETF shares by investors in
the secondary market may be subject to brokerage commissions and/or
transfer taxes associated with the trading and settlement through
Diversification and choice
Investment in an index tracking product will automatically
provide diversification across the sector covered by the index, the
actual level of diversification being determined by the specific
Available ETFs cover indices on most major equity markets as
well as regional, industry specific and country-specific sectors.
ETFs also cover other asset classes such as fixed income securities
with the range of available ETFs continuing to increase. This means
that with an ETF, an investor can gain a broad exposure to any
number of markets/sectors through the purchase of a single
As the components of the basket for the purchase or sale of
creation units are published on each dealing day, an ETF provides
greater portfolio transparency than a traditional investment fund
which would not publish portfolio holding information on a daily
basis and, if published, would generally be made on a lagged
periodic basis only.
Real-time pricing and intra-day trading
Intra-day trading enables investors to buy and sell their shares
at any time throughout the day, unlike traditional investment funds
which would generally deal only once a day (or less frequently).
ETFs therefore offer greater liquidity and opportunities to avail
of intra-day pricing changes.
In addition, by virtue of being listed on an exchange, investors
purchase ETF shares with real-time prices. This differs from
traditional investment funds, the shares/units in which are
purchased at forward prices. Shorting and margin As an ETF
share is an exchange traded security, it can be treated by
investors similar to an equity security and so can be sold short or
purchased on margin, subject to regulatory restrictions that may
Flexibility and range of investors
As ETFs can be openly purchased on an exchange there is normally
no requirement to open a specific account or provide any particular
documentation specifically for the ETF, although an account with a
broker/clearing system will generally be required to trade listed
ETFs are generally available to both retail and institutional
investors. They attract both active traders and long-term
investors. Investment managers may utilise ETFs where they find it
difficult to achieve out-performance of a market in a certain
sector or region.
How is an ETF constructed?
ETFs are typically established as index tracking funds where
they aim to track an index by holding a portfolio of securities
that represents or replicates the index, to the extent possible. As
a passive investment vehicle, the only trading activity conducted
by the ETF itself would be to reflect changes made to the index at
a rebalancing interval by making a corresponding change to its own
The ETF will be structured to offer shares to investors on the
secondary market, facilitated by...