AI: 74.c: The advantages and risks of ETFs

Advantages of ETFs. The broad spectrum of ETFs may have some of the following advantages relative to other equity investments:   ∙ ETFs provide an efficient method of diversification – one transaction yields exposure to a broad index or sector.   ∙ ETFs trade in a similar fashion to traditional equity investments – through an exchange – and can be shorted or margined. ETFs can be traded throughout the day with continuously updated prices, unlike traditional open-end funds that trade once a day at prices determined at the close of market.   ∙ Some ETFs are patterned after indexes that have active futures and option markets, allowing for better risk management.   ∙ ETF investors know the exact composition of the fund at all times through a daily, published list of underlying assets.   ∙ Because they are passively managed, ETFs typically have very efficient operating expense ratios, as well as no loads to purchase or redeem shares (just a normal commission) and a bid-ask spread.   ∙ The use of "in-kind" creation and redemption of shares eliminates any trading at a discount or premium to NAV. Authorized participants can create or redeem shares to capture any arbitrage opportunities.   ∙ Decreased capital gains tax liability for ETF shareholders compared to traditional open-end fund investors.   ∙ For some ETFs, dividends received may be reinvested immediately, as opposed to index funds whose timing may be delayed.

Disadvantages of ETFs. The disadvantages with investing in ETFs are as follows:   ∙ In some countries outside of the United States, there are fewer indices for ETFs to track, resulting in mid- or low-cap stocks not being well represented in the portfolio.   ∙ The ability to trade ETFs intraday may not be significant to those investors with longer time horizons.   ∙ Investors may encounter inefficient markets (large bid-ask spreads) in those ETFs with low trading volume.