Today, Ali Saadat Meli talks about ETF. Here ETF, Exchange Traded Fund, is an investment fund on the stock exchange. It has the objective of following the value of an index (for example, the SP500 index). And just like traditional funds, they can include a wide range of asset classes.
Ali Meli says traditionally, ETF had little media impact since it was considered another financial instrument. The first ETF was created in 1990 in Canada. It meant a transformation when investing because it allowed group investment and flexibility when buying and selling.
This first ETF replicated the value of the SP500. The variety in its types goes from indices of different countries to raw materials such as gold to shares of companies in a category such as alternative energies.
ETF Characteristics explained by Ali Meli
- Transparency: You will be able to know from the first minute the composition of the ETF portfolio, as well as all the relevant information about the products traded.
- Accessibility: Buying and selling is done quickly on online platforms like stocks.
- Liquidity: Related to everything said above, it can be sold and bought at any time since there is also always a specialist who, through their permanent presence, provides liquidity.
- Flexibility: Buy and sell at any time during the trading session.
- Variable income security: makes its price visible in real-time.
- Open: Any investor can access this vehicle as with shares.
How do ETFs work?
As Ali Saadat Meli said before, ETFs are listed on the stock market, so the way to acquire them is the same as shares. The only limitation is that operations must be done within trading hours. And the price is that of the underlying index or value it replicates.
The goal of ETFs based on a stock index is to replicate the value of the index, but you may need help understanding what an index is. Ali Saadat Meli shares details.
An index is a value used as a reference to know how certain companies perform on the stock market. There are two types of models:
Complete physical: In this case, the ETF physically owns the index’s components and is a replica of it. This is characterized by its simplicity and minimum tracking error (The tracking error describes the volatility of the difference in profitability between a specific portfolio or fund and its benchmark. The reference index used to follow a market’s evolution or measure performance. From a portfolio). Therefore, since it has a low tracking error, there is a greater probability that the behavior will be more similar to the index. Thus, all adjustments or changes in the index are replicated identically in the ETF.
Synthetic: Profitability is achieved through a swap (a contract between two parties with opposite interests; they commit to making a capital exchange under certain conditions). In synthetic ETFs, you enter into a swap with an investment bank.
Thus, the ETF tracks the value of the corresponding index.
Unlike the previous type, as explained by Ali Meli, where all efforts were directed at imitating an index as accurately as possible. This type of ETF has a manager who seeks a specific investment objective. They are rare.
- Raw Materials: The assets that comprise the ETF fund are from the commodity sectors such as precious metals (gold, silver, etc.), energy, and currencies.
- Inverses and leveraged: With inverse ETFs, returns are obtained when the following reference parameters are opposite. So when, for example, the SP500 is positive, the ETF will be negative and vice versa. On the other hand, leveraged ETFs aim to multiply the returns of the underlying they replicate. This may mean that you multiply by 2 or 3, the equivalent of your index, or that it decreases similarly.
Ali Saadat Meli concludes: Both are typical trading strategies, oriented so that operations are directed to meet objectives at most daily. Usually, it is intended to anticipate the market’s movement. And that is when the returns are obtained (be very careful with this type of an operation since it is elementary to lose all your investment).
Advantages of ETFs by Ali Saadat Meli:
- Transparency: From the first moment you know the ETF’s index or assets.
- Freedom to enter and exit: within trading hours, you can sell and buy whenever you want as if it is shared.
- Diversify: an ETF is like a basket. For the most part, as we have seen, they replicate an index that index is made up of different types of companies, so you diversify the risk. Or you can be even more specific and invest in other specialized indices in various sectors.
- Fewer commissions: you only have to pay the commissions of the broker that you use to carry out the operations.
- Variety of orders: Like buying stocks, you can set buy and sell orders (limit orders, buy on margin orders, etc.).
- It does not have a minimum investment: they do not require a minimum investment. You buy at market price and in the amount you want.