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 Introduction
ETFs are index funds that are listed and traded on stock exchanges like shares; they allow investors to gain a broad exposure to entire stock markets of different countries and specific sectors with relative ease, on a real-time basis and at a lower cost than many other forms of investing.
ETFs are basically a basket of securities that are traded on a stock exchange. They are structured as open-ended mutual fund to offer low-cost exposure to the stock market. Unlike mutual funds, ETFs can be traded throughout the trading day.
Exchange Traded Funds came into existence in 1993, when State Street Global Advisors, together with the American Stock Exchange, developed and launched the first ETF market. The name of the product was SPIDRERS (SPDR), which is an ETF, benchmarked against the S&P 500 Index. SPDR continues to be one of the most successful and liquid products.
By the end of November 2007, the number of ETFs world wide amounted to 1,137 ETFs managed by 73 managers and traded on 42 exchange platforms, with assets under management reaching $773.2 billion, as published in "Exchange Traded Funds-Industry Snapshot- End of November 2007", Morgan Stanley Institutional Equity.
Why invest in Exchange Traded Funds (ETFs)?
More Efficient and Economical
ETFs have lower management fees than traditional mutual funds. By investing in an ETF, you replicate the gains and losses of a basket of securities without the expense of buying all the underlying securities yourself.
More Transparent
Unlike mutual funds, you can view ETFs prices and trade ETFs anytime during the trading hours of EGX.
More Flexible
With ETFs, it is much easier to get a diversified portfolio of stocks than to pick individual stocks. Also, you simply call your broker to trade ETFs, as flexible as trading stocks.
More Diversified
ETFs invest in a portfolio of securities, to provide diversified exposure to selected markets or sectors.
More Liquid
ETFs are continuously traded on EGX during trading hours. ETFs have market makers who act as counterparties to buyers and sellers in the trade execution process. Market makers ensure the liquidity of ETFs on EGX.
More Features
Investors can use a limit order, buy on margin (after EGX approval) and invest as much or as little money as they wish (there is no minimum investment requirement) in ETFs. Mutual funds do not offer these features.
What are the risks associated with the investment in ETFs?
- Market risk: an ETF represents investment in a portfolio of securities. Hence, the performance of the ETF will be directly affected by the performance of its constituent securities. In other words, an ETF tracking an index would be affected by the performance of the index.
- Tracking error: an ETF may not be able to exactly replicate the performance of the underlying index due to management fees, timing differences and other factors.
- Foreign exchange risk: investors whose base currency is other than the currency denomination of the ETF will be subject to the risk of fluctuations in currency values.
The following table compares an ETF with a mutual fund and an individual stock to illustrate similarities and differences between the three instruments:
|
Attribute
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ETF
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Index Mutual Fund
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Individual Stock
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|
Diversification
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Yes
|
Yes
|
No
|
|
Traded throughout the day
|
Yes
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No
|
Yes
|
|
Can be bought on margin (after EGX approval)
|
Yes
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No
|
Yes
|
|
Tracks an index or sector
|
Yes
|
Yes
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No
|
|
Low Expense Ratio
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Yes
|
Sometimes |
Not a factor
|
Trade at any brokerage firm
|
Yes
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No
|
Yes
|
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