The whole truth about ETFs in the US market

Trading on Wall Street has undergone fundamental changes in recent years. Investing has become even easier, while the increasingly sophisticated needs of market participants are satisfied at minimal cost.

We are talking about the explosive growth of exchange-traded funds ETFs. The total assets under management of these funds in the United States amount to about $2.8 trillion. At the same time, the United States dominates the global ETF market, accounting for more than 80% of assets under management.

What is an ETF?

Exchange Traded Funds are exchange-traded funds that invest in specific assets or groups of assets. Essentially, they own underlying assets (stocks, bonds, commodity futures, foreign currencies, etc.) and issue securities on them. As asset values ​​change, so does the price of the ETF. Ideally, ETF securities follow portfolio changes fairly accurately.

According TheCommodityTower.com conceptually, ETFs are in many ways similar to mutual funds (mutual funds in the US market), but there is one significant difference. ETFs are EXCHANGE-TRADE instruments! This has a number of advantages, which we will discuss in the next section.

The global ETF market is essentially controlled by three financial entities: BlackRock (iShares), Vanguard and State Street Global Advisors (SPDR ETF). As of mid-2016, institutions accounted for 70% of global ETF assets. No other entity controls more than 4% of total assets.

Benefits of ETFs
- Exchange instruments - this provides intraday liquidity. In terms of trading method, ETFs are similar to stocks.

- Unlike stocks, ETFs are more diversified, which reduces their exposure to the risks of an individual company whose fundamentals or news background may unexpectedly worsen.

- Lower commissions compared to traditional funds, due to optimization of management costs.

- Transparency - ETF assets are published regularly, so investors are constantly aware of all changes.
- Big choice. Often, ETFs are focused on a specific index (S&P 500, NASDAQ 100, etc.). Sector ETFs are also widely used. Investments in individual regions are possible, for example through iShares MSCI Emerging Mkts. Commodity markets are also covered. ETFs can differ in investment styles (growth or income stocks), market capitalization of investment objects. There are even exotic niche ETFs based on current trends. And that’s not all; we’ll look at different types of ETFs in more detail in a separate section.

- Variety of strategies. A bet can be made on a wide market or, conversely, on exotic destinations. We can talk about greater diversification of investments or targeted trades. Both active and passive investing techniques are available. It is possible to open both longs and shorts, trade with leverage, and trade with options on ETFs. There are even “inverted” ETFs, the purchase of which involves taking a short position in a given asset.

- Access to “privileged” assets. For example, many bonds are available for purchase only in large lots. However, ETFs allow for more moderate investments that are acceptable for private investors. Thus, the opportunities for portfolio diversification are further increased.

Disadvantages and risks of ETFs

- During the trading day, securities may trade at a premium or discount to their net asset value (NAV), which may adversely affect the income of a short-term speculator. Moreover, not all ETFs accurately reflect portfolio fluctuations.

- With the growth in the number of ETFs, exotic securities have appeared, which are often less liquid and less understandable for investors, requiring careful preliminary analysis. Over the course of a year, the dynamics of the “best” and “worst” ETFs formally in one area (for example, biotechnology) can vary significantly.

- Losses are possible on country securities while the index on which they rely is closed due to extreme circumstances. A similar thing happened with the Market Vectors Egypt ETF during the Arab Spring.

- There have been cases of ETF liquidation. This happened to about 130 funds last year due to increased competition in niche securities, in particular the commodities and Japanese sectors. In theory, cash is reimbursed to investors, but may be subject to transaction costs.

How to choose an ETF?

- It is necessary to formulate an investment strategy: active or passive, defensive or risky. The objectives of investing in ETFs are: concentration, diversification or hedging. Select the main types of assets interesting for investment. It is important to understand what portfolio underlies the ETF and what purposes it can serve;