Meaning of ETF
According to abbreviationfinder, ETF is the abbreviation for “Exchange Traded Fund”. Accordingly, ETFs are not traded through the investment companies that set up the respective funds, but on the stock exchange. The price of ETFs is based solely on supply and demand, i.e. purchases and sales on the stock exchange. The fund company’s issuing surcharge does not apply. The support is not provided by fund managers, but by market makers. Their task is to determine the buying and selling prices, which are published continuously during the trading day. Therefore, the development of the ETFs is very transparent.
- The majority of exchange-traded funds are offered as index funds, which is why both terms are often used synonymously.
- In most cases, ETFs are based on stock indices due to their large number.
- One of the great advantages of ETFs over other fund investments is the flexibility of stock exchange trading.
- The risk of an exchange traded fund depends on the type of fund and the underlying indices.
Participation in index developments
The majority of exchange-traded funds are offered as index funds, which is why both terms are often used synonymously. Index funds are passively managed, which means that they track the development of a specific underlying index. Actively managed ETFs that invest the fund capital in constantly changing, successful values in order to optimize returns and beat indices are extremely rare.
In most cases, ETFs are based on stock indices due to their large number. The best-known share index in Germany that a listed fund can use for orientation is the German share index DAX. This index summarizes the securities of the 30 stock corporations with the highest turnover in Germany. But there is also the possibility of replicating real estate, money market or other indices.
In principle, an ETF can track any index. Depending on the type, they differ for example:
- Market-wide indices with stocks from all industries and regions (e.g. the MSCI All Country World Index, which takes industrialized and developing countries and small and large companies into account)
- Region indices with values from individual economic regions (for example the MSCI Europe Index, which only includes European stocks, or the MSCI Emerging Markets Index, which only includes stocks from developing countries)
- Sector indices that only show the development in a certain branch of the economy (for example the Euro Stoxx Telecommunications Index)
- Strategy indices that focus on specific industries, growth rates, or time-based data
Advantages of ETFs
One of the great advantages of ETFs over other fund investments is the flexibility of stock exchange trading. The listed funds can be quickly liquidated on the stock exchange, so that investors have access to the sales proceeds after just a few days.
Since passively managed ETFs follow changes in the indices, active management that constantly monitors the market and reacts to market changes with new investment strategies is not required. Fund managers don’t have to be paid. The costs are limited to the exchange fee and the total expense ratio charged to the fund and are significantly lower than when purchasing actively managed fund units. This means that passively managed ETFs are also of interest to private investors.
Disadvantages compared to active funds
A disadvantage of passively managed ETFs compared to actively managed funds is that the return is firmly linked to the performance of the underlying index. Ultimately, you aim to map the base index as precisely as possible. Active funds, on the other hand, aim to outperform their benchmark. To achieve this, fund managers change the composition of the fund and fill it with the strongest values if possible. In practice, however, it is seldom possible to permanently outperform the index.
Risks and selection of ETFs
The risk of an exchange traded fund depends on the type of fund and the underlying indices. Safe investments include ETFs that fully track a market-wide index. These funds are characterized by a large diversification of the fund capital. The strength of the index also influences the safety of ETFs. Nevertheless, a risk of loss in stock exchange transactions cannot be ruled out. Before investing in exchange-traded funds, it is worth comparing the offers.