The prospect of leaving one's fortunes in the hands of a small number of authorised participants may be enough to dissuade some people from investing in ETFs. However, ETFs are an excellent option for investors looking for a particular kind of asset. Below are a few of the main advantages of ETFs:
- Diversification – By default, ETFs naturally diversify in order to create a lucrative set of investments capable of attracting new investors. Diversification almost always equals stability and loss control.
- Minimum Deposits – ETFs have no minimum deposit requirements. Therefore, a limited investor could buy just one share if that's all he or she wanted.
- Lower Expense Ratios – It generally costs less for managers to operate an ETF than a standard mutual fund. This translates to lower costs for investors as well.
- Short Sales – ETF investors are allowed to short sell if they believe it would be advantageous. They simply sell their shares back to the fund, wait until share value drops to a target level, then repurchase shares to take advantage of future growth.
- Marginal Purchases – ETFs also allow for marginal purchases. In other words, the investor makes an initial down payment to buy shares and then borrows what is necessary to make up the difference.
ETF investing is a short-term strategy that relies heavily on correctly predicting market volatility and interest rates. It represents a good way to earn substantial yields with limited risk, but only if the investor invests wisely.
Dissecting the ETF
How an ETF is structured is that which gives it its strength for short-term investing. As a fund attracting investments from multiple participants, the ETF utilises its pooled resources to purchase assets such as stocks, precious metals, bonds, commodities, futures, and so on. Fund managers then divide up those assets among investors with equal shares going to each. The value of each investor's participation is represented as shares of the fund.
Every participating investor in an ETF is considered a legal shareholder. However, they do not own any of the investment assets directly, nor can they make any direct claims on those assets. They are asset owners only indirectly. That said, shareholders are entitled to receive a proportion of the fund's profits based on the shares they hold. Those profits can be distributed as dividends or interest. In the event a fund shuts down, each shareholder is entitled to residual value based on participation.
In terms of buying and selling shares, participating in an ETF fund is significantly different compared to mutual or index fund investing. Rather than simply buying and selling, ETFs must create and redeem shares based on the group of assets under management. Shares are created and redeemed by a small number of fund investors known as authorised participants.
If these investors want to create new shares, they simply invest in a new group of assets which then become the property of the fund and can be distributed as shares to other investors interested in purchasing them. Likewise, authorised participants can choose to sell a group of assets, thereby redeeming shares and returning their value to the fund and its investors.