Exchange-Traded Funds (ETFs)
An exchange-traded fund, or ETF, is a type of investment company whose
investment objective is to achieve the same return as a particular market
index. An ETF is similar to an index fund in that it will primarily invest
in the securities of companies that are included in a selected market index.
An ETF will invest in either all of the securities or a representative
sample of the securities included in the index. For example, one type of
ETF, known as Spiders or SPDRs, invests in all of the stocks contained in
the S&P 500 Composite Stock Price Index.
Hyperlinks in this color go directly to the
Securities and Exchange Commission website.
Although ETFs are legally classified as
open-end companies or
Unit Investment Trusts (UITs),
they differ from traditional open-end companies and UITs in the following
respects:
- ETFs do not sell individual shares directly to investors and only
issue their shares in large blocks (blocks of 50,000 shares, for example)
that are known as "Creation Units."
Investors generally do not purchase Creation Units with cash. Instead,
they buy Creation Units with a basket of securities that generally mirrors
the ETF’s portfolio. Those who purchase Creation Units are frequently
institutions.
After purchasing a Creation Unit, an investor often splits it up and
sells the individual shares on a secondary market. This permits other
investors to purchase individual shares (instead of Creation Units).
Investors who want to sell their ETF shares have two options: (1) they
can sell individual shares to other investors on the secondary market, or
(2) they can sell the Creation Units back to the ETF. In addition, ETFs
generally redeem Creation Units by giving investors the securities that
comprise the portfolio instead of cash. So, for example, an ETF invested
in the stocks contained in the Dow Jones Industrial Average (DJIA) would
give a redeeming shareholder the actual securities that constitute the
DJIA instead of cash. Because of the limited redeemability of ETF shares,
ETFs are not considered to be—and may not call themselves—mutual funds.
An ETF, like any other type of investment company, will have a
prospectus. All investors that purchase Creation Units receive a prospectus.
Some ETFs also deliver a prospectus to secondary market purchasers. ETFs
that do not deliver a prospectus are required to give investors a document
known as a Product Description, which summarizes key information about the
ETF and explains how to obtain a prospectus. All ETFs will deliver a
prospectus upon request. ETFs do not use profiles. ETFs that are legally
structured as open-end companies (but not those that are structured as UITs)
must also have statements of additional information (SAIs). Open-end ETFs
(but not UIT ETFs) must provide shareholders with annual and semi-annual
reports. Before purchasing ETF shares, you should carefully
read all of an ETF’s
available information, including its prospectus.
The website of the
American Stock Exchange
provides more information about different types
of ETFs and how they work. You can also find detailed information about
ETFs on the website of
The Nasdaq Stock Market. An ETF will have
annual operating
expenses and may also impose certain
shareholders
fees that are disclosed in the prospectus.
The above content source is copied directly from the Securities And
Exchange Commission website on Exchange Traded Funds. (ETF'S)
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