An exchange-traded fund (ETF) is a basket of securities that may consist of stocks, bonds, commodities, real estate, or other financial assets. By design, ETFs strive to offer more liquidity and trading flexibility than other investment vehicles. That is because they are bought and sold on an exchange, much like individual stocks, where supply and demand continually dictate share prices. Investors can make trades during normal market hours in response to new market conditions or changing expectations.
ETFs also serves as a versatile asset. They are structured in a way that lets investors target a specific category of investment, such as an asset class, sector, or geographic region. Many ETFs track a specific index focused on a market segment, such as the Standard & Poor’s 500 Index for U.S. large-capitalization stocks. Such funds are considered “passive investments” because they simply mirror the composition of a particular index.
Actively managed ETFs, on the other hand, offer the opportunity to beat the returns of an index because an investment manager selects which securities to own in the portfolio. Even if the fund focuses on a particular market segment, the manager has the discretion to determine which securities to own.
Investors are drawn to the structural characteristics of ETFs:
- Tax-advantaged design: Because of how they are structured, ETFs generally do not issue the annual taxable capital gains distributions that mutual funds do.
- Portfolio transparency: ETFs report their underlying securities on a daily basis, which means investors immediately know what they are holding.
- Low turnover: Since some ETFs track indexes or baskets of securities, the internal turnover of securities in the portfolio is generally lower than the turnover rate for actively managed mutual funds.
- Targeted exposure: Investors can use ETFs to dial up or down their overall portfolio’s exposure to different markets, styles, sectors, themes, or strategies.
- Liquidity/flexibility: Investors can buy and sell shares on exchanges throughout the trading day, while also implementing different strategies such as buying on margin, short selling, and placing various order types.
- Accessibility: ETFs provide access to asset classes, such as certain types of commodities, that were previously available only to institutional investors.
- Lower ownership cost*: Passive investments, which track an index or sector, may have lower expense ratios because simply mirroring an index in less costly than having a team of investment managers evaluate and select securities.
Investors should be aware of the material differences between mutual funds and ETFs. ETFs generally have lower expenses than actively managed mutual funds due to their different management styles. Most ETFs are passively managed and are structured to track an index, whereas many mutual funds are actively managed and thus have higher management fees. Unlike ETFs, actively managed mutual funds have the ability react to market changes and the potential to outperform a stated benchmark. ETFs can be traded throughout the day, whereas, mutual funds are traded only once a day. While extreme market conditions could result in illiquidity for ETFs. Typically they are still more liquid than most traditional mutual funds because they trade on exchanges. Investors should talk with their advisers regarding their situation before investing.
Invesco does not offer tax advice. Please consult your own tax advisor for information regarding your own tax situation. While it is not Invesco' intention, there is no guarantee that a Fund will not distribute capital gains to its shareholders.
* Since ordinary brokerage commissions apply for each buy and sell transaction, frequent trading activity may increase the cost of owning ETFs.