Introduction to Exchange Traded Funds: Features

Submitted by Sharemarket News on 1 July, 2011 - 18:05

Everything about Exchange Traded Funds (ETFs).

To learn more about your ETF, you can go to the ASX and the ETF issuer website where you will find distribution, market prices (ASX prices are delayed by at least 20 minutes) and company details and announcements.

Net Asset Value

Net asset value (NAV) is the ETF's per-share value. NAV is calculated by dividing the total value of all securities in its portfolio, less any liabilities, by the number of fund shares outstanding. You can find the NAV in the issuer's website and under the Company Announcement section of the ASX website.

You may notice the iNAV or indicative NAV, which some ETFs over Australian indices also provide. The iNAV, if available, is updated during the trading day and can be found in the issuer's website. Just prefix the ASX code for the ETF with the letter “Y” to get the iNAV.

ETFs trade like stocks, so their shares trade at market value. This can be a dollar value above or below the NAV.

Market Makers

Professional traders who make bids and offers available for you to trade with are called Market Makers. The ETF issuer needs to ensure that at least one market maker is present for the ETF. Market makers also have the right to redeem units with the ETF issuer or create units.

How the ETF Market is Made

To be able to calculate the NAV during daily trading, the ETF issuer reports the composition of the securities underlying the ETF. This results in a "spread" around the ETF, a bid price at which the market makers will buy the ETF or an offer price at which they will sell it. These quotes and the resulting NAV are updated as underlying securities change and published on the ASX.

Let's take a closer look at the spread. The spread is the price market makers are willing to buy, which is lower than the price they are willing to sell. A tighter bid-offer spread is better for investors. Sometimes you will see only one bid and one offer value on the broker's website. This usually means a quote from a market maker, which will be replaced with another quote if the first one is hit.

Under normal market conditions, market makers ensure you have someone to trade with. In times of high volatility, however, the ability to generate trades may be curtailed and quotes that you want to trade with cannot be guaranteed.

International ETFs

International ETFs are issued in the US and are declared in US dollars, which are then converted to Australian dollars before being paid to you. Although subject subject to withholding tax, you can usually claim the amount offset against your Australian tax.

Points to Remember about ETFs

  • From tracking only broad market stock indices, ETFs have evolved to replicate just about any index. One requirement is enough investor interest to make the ETF profitable.
  • ETFs are traded like stocks on the Australian sharemarket. The difference with regular share trading is that ETF pools your capital investment along with those from other people, and a fund manager overlooks the lot. ETFs are usually passively managed.
  • It's important for the investor to evaluate options before buying ETFs. Since the choices run from equities to foreign stocks, careful evaluation is needed to select an ETF in line with trading goals.