Debt Dictionary

Exchange-traded Funds

Investment Dictionary -> Exchange-traded Funds

Important components of the portfolio of any investor are the Exchange-traded funds (ETFs). This is true for both, the novice investors and the most sophisticated money managers. Some even use the ETFs as the only focus of their portfolios provided that they are capable of building a diversified portfolio composed of just a few ETFs. Sometimes, the exchange-traded funds just compliment the portfolios of managers. The latter rely on them for the implementation of investment strategies which may be quite sophisticated. To benefit from ETFs, investors must use and understand the tool in an appropriate manner.

The understanding of most ETFs is a straightforward task. They will resemble stock on an exchange, coming closer to mutual funds. The mutual fund tracks some underlying index and while the ETF is designed to replicate this index. A part of the investment characteristics that differ explain the structural difference between the mutual funds and the ETFs. The management style explains the rest of the differences.

The ETF is considered a passively managed fund because the design which enables the instrument to track an index. Mutual funds are generally considered to be actively managed.

An investment in the ETF or an index mutual fund is considered to be an equivalent investment, from the view point of the investor.
The index mutual funds are viewed as covering nearly all of the major indexes. ETFs also list a broad range and provide even more investment options to individuals who decide to choose them, rather than the index mutual fund.

Similarly to other types of investment companies, ETFs have a prospectus. The purchase of Creation Units by investors entitles them to a prospectus. Sometimes, even secondary market purchasers are delivered a prospectus. The ETFs that do not deliver must send a document named Product Description to the investors.

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