Exchange traded funds (ETFs) are index-tracking funds that can be traded on exchanges just like a stock – so they combine the diversified holdings of a fund with the low cost and tradability of a share.
ETFs work rather like index-tracker unit trusts or open-ended investment companies (Oeics), holding a portfolio of shares, commodities or other securities to replicate the performance or an index, sector or asset class. However, they generally have lower management charges, and can be bought and sold at any time through a stockbroker, rather like closed-ended investment trusts. Also, like investment trusts, their prices change continuously throughout the trading day, reflecting the value of the assets they track and sentiment in the market.
ETFs track an index in two broad manners. A physical ETF holds the same percentage of the underlying stocks of the index as is represented by their percentage of the index. So, for example, if a stock represents 2 per cent of an index, then 2 per cent of the value of the ETF holdings will be in that stock. A synthetic ETF uses derivatives to achieve the same returns as the index it tracks.
Well-known providers of ETFs include iShares, Vanguard and State Street. ETFs have grown in popularity because of their low fees, tradability (that is liquid and traded on exchanges), tax efficiency and diversification benefits.
In January 2014 the FT reported on ETF inflows for the previous year. Net global inflows to BlackRock's range of iShares exchange traded funds and products dropped 30 per cent to just over $61bn in 2013 while Vanguard, which enjoyed its best year ever, won $60.2bn, an increase of 12.5 per cent on 2012.