An exchange-traded fund (ETF) is an investment fund traded on stock exchanges, much like

stocks.[1] An ETF holds assets such as stocks, commodities, or bonds and trades at approximately
the same price as the net asset value of its underlying assets over the course of the trading day.
Most ETFs track an index, such as the S&P 500 or MSCI EAFE. ETFs may be attractive as
investments because of their low costs, tax efficiency, and stock-like features.[2][3] ETFs are the
most popular type of exchange-traded product.

Only so-called authorized participants (typically, large institutional investors) actually buy or
sell shares of an ETF directly from or to the fund manager, and then only in creation units, large
blocks of tens of thousands of ETF shares, which are usually exchanged in-kind with baskets of
the underlying securities. Authorized participants may wish to invest in the ETF shares for the
long-term, but usually act as market makers on the open market, using their ability to exchange
creation units with their underlying securities to provide liquidity of the ETF shares and help
ensure that their intraday market price approximates to the net asset value of the underlying
assets.[4] Other investors, such as individuals using a retail broker, trade ETF shares on this
secondary market.

An ETF combines the valuation feature of a mutual fund or unit investment trust, which can be
bought or sold at the end of each trading day for its net asset value, with the tradability feature of
a closed-end fund, which trades throughout the trading day at prices that may be more or less
than its net asset value.

Types of ETFs

Index ETFs

Most ETFs are index funds that hold securities and attempt to replicate the performance of a
stock market index. An index fund seeks to track the performance of an index by holding in its
portfolio either the contents of the index or a representative sample of the securities in the index.

Commodity ETFs or ETCs

Commodity ETFs invest in commodities, such as precious metals and futures. Among the first
commodity ETFs were gold exchange-traded funds, which have been offered in a number of
countries.

Bond ETFs

Exchange-traded funds that invest in bonds are known as bond ETFs.

Currency ETFs or ETCs

In 2005, Rydex Investments launched the first ever currency ETF called the Euro Currency Trust
(NYSE: FXE) in New York. Since then Rydex has launched a series of funds tracking all major
currencies under their brand CurrencyShares.
Actively managed ETFs

Actively managed ETFs are quite recent in the United States. The first one was offered in March
2008 but was liquidated in October 2008. The actively managed ETFs approved to date are fully
transparent, publishing their current securities portfolios on their web sites daily. However, the
SEC has indicated that it is willing to consider allowing actively managed ETFs that are not fully
transparent in the future.[4]

Leveraged ETFs

Leveraged exchange-traded funds (LETFs), or simply leveraged ETFs, are a special type of ETF
that attempt to achieve returns that are more sensitive to market movements than non-leveraged
ETFs

Advantages of ETFs

1. ETFs tend to be more cost-effective vis-a-vis comparable mutual funds. For instance,
while the expense ratio of a passively managed ETF (tracking a benchmark index) would
normally be in the range of 0.50%-1.00%; for an index fund, it can be as high as 1.50%.

2. Another important advantage with ETFs is that they provide more flexibility to investors
than regular mutual funds. Since they are traded on the stock exchange, they are available to
investors any time during the trading hours. So investors can buy and sell units of an ETF on a
real time basis, unlike regular mutual funds, which can be transacted only at end-of-day NAV.

3. Since ETFs witness most of the buying/selling on the exchange, the interests of the long-
term investor are not compromised. Take a regular equity fund where units are bought and
sold at the AMC’s end – when a significant amount of money enters and exits the fund rather
quickly, the long-term investor could suffer as a result of the costs (trading costs, registrar costs
and opportunity loss, if the fund manager is forced to sell his best stocks) associated with this
quick inflow/outflow.

With an ETF, since the trading investor does not approach the AMC at all and only interacts with
other investors over the exchange, his quick entry/exit does not compromise the interests of the
long-term investor.

4. Given ETFs are traded on the stock exchange, and can be bought/sold on a real time basis;
they tend to have low tracking error (deviation of ETF’s performance from that of the
underlying index) as compared to index funds.

Disadvantages of ETF

1. Investors need to have a demat and a trading account, with a SEBI registered stockbroker,
for investing in ETFs. For investors, who do not trade in stocks, this could be a bit of a deterrent.
Also, maintaining a demat account entails paying annual fees (approximately Rs 500), however
the same varies across stockbrokers. For investors, who invest in stocks, this will not pinch as the
maintenance charge of the demat account will be spread across the stock and ETF investments.

2. While investors have to incur entry/exit loads at the time of making/redeeming investments in
mutual funds, for ETFs they have to pay a brokerage (usually around 0.50%) to the
stockbroker, along with other applicable charges (STT for instance), every time ETF units are
bought or sold. For a trader who frequently trades, this can have a significant impact on the net
returns. But for long-term investors, these expenses hold little relevance.

1. Advantage: Foreign Exposure

If you feel there are some foreign regions that are potential growth areas or emerging markets, a country
ETF may be the perfect asset to increase your international exposure.

2. Disadvantage: Taxes

ETFs are known for their tax advantages. However, every country has different tax laws, so there may be
particular foreign ETFs that are not a good fit for your etf trading strategy if they have a negative effect on
your tax return. Make sure you research all tax laws of the region for your ETF before you make the
investment.

3. Advantage: Diversification
If your portfolio is heavy on domestic investments, some foreign exposure may help balance your overall
stratagem. Adding a country or region ETF to your portfolio can expand your investment horizon.

4. Disadvantage: Currency Rates

While adding a foreign ETF may be a boon to your portfolio, you have to factor in the currency rates of your
ETF region. If currency rates are skewed, a country ETF may not be the best match for your portfolio.

5. Advantage: Risk Management

If your portfolio or business has exposure to a certain region, investing in a foreign ETF may be a good way
to reduce that risk and protect yourself against negative developments in certain countries.

6. Disadvantage: Flexibility

While the US has a lot of different ETF products to add to your portfolio, the selection may be sparse for
other countries. Many regions don’t have a lot of ETFs, and they aren’t always to most liquid investments.
Trading activity for foreign ETFs can be limited and in turn limit your investment strategy.

While foreign ETFs can help minimize risk, gain international exposure, and diversify your portfolio, you
have to weigh the disadvantages of region ETFs before you get started and make your final decision to
include them in your portfolio.

Roles

Growing use of exchange traded funds has contributed to an increase in correlations between individual equities,
posing particular problems for long-short equity hedge funds, according to Hennessee Group, the consultant.
growing popularity of ETFs and their rising share of overall trading volumes was contributing to the stock market
being driven more by sentiment about broad economic issues rather than company fundamentals
imp
Asset Allocation : Asset allocation managing could be difficult for individual investors given the costs and assets required to achieve proper
levels of diversification. ETFs provide investors with exposure to broad segments of the equity markets. They cover a range of style and size
spectrums, enabling investors to build customized investment portfolios consistent with their financial needs, risk tolerance, and investment
horizon. Both institutional and individual investors use ETFs to conveniently, efficiently, and cost effectively allocate their assets.

Cash Equitisation : Investors typically seek exposure to equity markets, but often need time to make investment decisions. ETFs provide a
"Parking Place" for cash that is designated for equity investment. Because ETFs are liquid, investors can participate in the market while
deciding where to invest the funds for the longer-term, thus avoiding potential opportunity costs. Historically, investors have relied heavily
on derivatives to achieve temporary exposure. However, derivatives are not always a practical solution. The large denomination of most
derivative contracts can preclude investors, both Institutional and Individual, from using them to gain market exposure. In this case and in
those where derivative use may be restricted, ETFs are a practical alternative.

Hedging Risks : ETFs are an excellent hedging vehicle because they can be borrowed and sold short. The smaller denominations in which
ETFs trade relative to most derivative contracts provides a more accurate risk exposure match, particularly for small investment portfolios.

Arbitrage (Cash Vs Futures) and Covered Option Strategies: ETFs can be used to arbitrage between Cash and Futures Market, as it is
very easy to trade. ETFs can also be used for cover Option strategies on the Index.