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WHAT IS AN ETF?
An Exchange Traded Fund or ETF is an open-end investment company that trades its shares in the stock exchange. An ETF company issues its shares in blocks called "Creation Units" in exchange for a basket of securities comprising the index it wishes to track. Creation is normally done by institutional investors, who break down the block into smaller portions and sell to retail investors in the Exchange.
ETFs have become one of the fastest growing investments in the world because they are simple to understand and provide opportunities for investors to create a diversified portfolio of stock with lower investment costs. Various funds have also set up ETFs because they are simpler to administer and have lower expense requirements compared to mutual funds or unit investment trust funds.
WHAT IS AN INDEX?
Index is an indicator to measure or monitor the performance of a group of securities. For the PSE, its main index is the PSEi, which is composed of 30 of the largest and most liquid stocks.
In the case of the PSEi as seen in the graph, if ETFs were available at the start of 2009, the likely 4-year return of the ETF investment would have been 194.4% for a compounded annual growth rate of 31.0%.
WHY INVEST IN ETFs?
ETFs provide numerous advantages and benefits to investors, as follows:
COMPARISON OF INVESTMENT FUNDS
(*) NAV - Net Asset Value iNAV - indicative Net Asset Value
How can I get ETF shares?
Just like ordinary stocks ETFs can be bought in the stock market through brokers. In addition, large retail or institutional Iinvestors that can supply the minimum number of underlying shares or basket of securities required to form a Creation Unit, can exchange such shares for ETF shares through a trading participant (brokers) authorized upon instruction by the ETF Company. This process is called "creation". These investors will eventually break down the block of ETF shares into smaller portions and sell through the Exchange, Other all investors may now buy and sell through its trading participants (broker), just like any other stock.
Retail investors buy and sell ETF shares just as they would trades shares of any listed company
How much is minimum investment required to trade ETFs?
The minimum investment depends on the requirement of trading participants (brokers). Some trading participants (brokers) allow investments amounting to as low as Php5,000.
How do investors select which ETF to invest in?
The choice of the investor will depend on his investment objectives. Different ETFs can track different indices. In some markets, ETFs track sector-specific indices. For ETFs tracking the same index, an investor can base his decision on the capability of the ETF to closely track the index, as well as the general track record of the ETF company. Details and other information about an ETF are disclosed to the PSE and are available in both the websites of the ETF company and the PSE.
Do ETFs distribute dividends?
Just like stocks, the decision to distribute dividends depends on the company''s dividend policy or the decision of its board to do so.
What is the importance of posting the iNAV every minute?
The Indicative Net Asset Value, or iNAV, is an indication of the current net value of the ETF shares'' underlying securities and given on a per share basis. The iNAV is provided on a per minute basis during trading hours so as to timely guide investors on the movements of the ETF price vis-à-vis its underlying securities.
These two figures, the ETF share market price and the iNAV, give investors opportunities to arbitrage. Arbitrage is the almost simultaneous purchase and sale of similar or identical assets in order to profit from a difference in prices.
What is the importance of NAV?
An ETF''s Net Asset Value (NAV) is calculated and available at the end of trading day and gives a view on the size and performance of the fund. Creation and redemption of ETF shares are based on NAV.
What is tracking error and why is it important?
Tracking error is a measure of how well the ETF is able to track the index. A lower value indicates better performance of the fund. The tracking error is the standard deviation of the difference in relative returns between the ETF and its underlying index. A number of factors may cause the tracking error to increase, such as: the composition of the underlying assets, the fund''s cash component, dividends and expenses such as management fees. ETFs have to disclose the maximum level of tracking error in its prospectus.
How does the creation and redemption process work?
ETF processes involving creation and redemption of shares can occur any time during trading hours. In the creation, the trading participant authorized by the ETF Company, called the Authorized Participant, surrenders the underlying shares to ETF Company and in return, the ETF Company gives equivalent ETF shares in Creation Units to Authorized Participant. In general, Creation is undertaken when the relative value of the underlying shares (as evidenced by the iNAV) is cheaper than the ETF shares. Thus, participants can buy relatively lower priced underlying shares and exchange them for ETF shares which may be trading at a premium.
Steps in Creation
Step 1 - Request for creation: Cross transaction done through PSE, where Authorized Participant surrenders underlying shares to the ETF Company in exchange for ETF shares.
Step 2 - The Authorized Participant surrenders underlying shares to the Custodian.
Step 3 - The Custodian confirms availability of underlying shares.
Step 4 - ETF Company instructs the Transfer Agent that ETF shares can be issued.
Step 5 - Transfer Agent performs book entry movement of new ETF shares to be issued to the Authorized Participant.
Redemption is simply the reverse. The Authorized Participant surrenders ETF shares to the ETF Company in exchange for the corresponding underlying shares. This is undertaken when the ETF shares price is relatively cheaper than the value of the underlying shares.
KEY PARTIES TO AN ETF
An Exchange Traded Fund or ETF is an open-end investment company that trades its shares in the stock exchange. An ETF company issues its shares in blocks called "Creation Units" in exchange for a basket of securities comprising the index it wishes to track. Creation is normally done by institutional investors, who break down the block into smaller portions and sell to retail investors in the Exchange.
ETFs have become one of the fastest growing investments in the world because they are simple to understand and provide opportunities for investors to create a diversified portfolio of stock with lower investment costs. Various funds have also set up ETFs because they are simpler to administer and have lower expense requirements compared to mutual funds or unit investment trust funds.
WHAT IS AN INDEX?
Index is an indicator to measure or monitor the performance of a group of securities. For the PSE, its main index is the PSEi, which is composed of 30 of the largest and most liquid stocks.
In the case of the PSEi as seen in the graph, if ETFs were available at the start of 2009, the likely 4-year return of the ETF investment would have been 194.4% for a compounded annual growth rate of 31.0%.
WHY INVEST IN ETFs?
ETFs provide numerous advantages and benefits to investors, as follows:
- Investors can diversify their investments in stocks with minimal capital outlay, allowing smaller retail investors to have access to blue chip companies. Diversification is an investment strategy that allows attainment of long-term goals while minimizing risk.
- Investors, especially those who do not have enough time to monitor the stock market, can enjoy the returns of the overall market without having to actively manage their portfolio.
- Since ETFs are traded in the Exchange, investors can immediately find out the ETF price (i.e. real-time) without having to wait for end-of-day, as observed in other investment funds.
- Unlike other investment funds, ETFs have no sales-load commissions.
- Some investment funds require a holding period and impose a surcharge on pre-termination. ETFs do not have this restriction, as it may be purchased and sold anytime during trading hours.
- Investors know the composition of securities the ETF company has (i.e. the index components) because they are required to disclose this information. Other investment funds may opt to actively manage the fund and change the composition of its investment in securities without the prior knowledge of the investor.
- ETFs present new opportunities for participants to earn returns through arbitrage, making this product attractive to institutional investors.
- Investors can return the ETF shares in quantities of the Creation Unit in exchange for the underlying shares (i.e. the basket of securities).
COMPARISON OF INVESTMENT FUNDS
| Dimension | ETF | Mutual fund | UITF |
|---|---|---|---|
| Intraday Trading | Yes | No | No |
| Publication of NAV / iNAV (*) | iNAV every minute and NAV at end-of-day | NAV at end-of-day | NAV at end-of-day |
| Management | Generally Passive | Usually Active | Can be both |
| Fees / Costs Involved fees | Similar to trading a stock - brokers commission, transaction fees, etc. *no sales load, no preterm fees | Front end load, back end load, redemption fee (if held less than the minimum time required) | Early redemption fee |
| Management Fees | Lower management fees | Higher management fees | Higher trustee fee |
| Redemption | Securities and/or Cash | Cash | Cash |
How can I get ETF shares?
Just like ordinary stocks ETFs can be bought in the stock market through brokers. In addition, large retail or institutional Iinvestors that can supply the minimum number of underlying shares or basket of securities required to form a Creation Unit, can exchange such shares for ETF shares through a trading participant (brokers) authorized upon instruction by the ETF Company. This process is called "creation". These investors will eventually break down the block of ETF shares into smaller portions and sell through the Exchange, Other all investors may now buy and sell through its trading participants (broker), just like any other stock.
Retail investors buy and sell ETF shares just as they would trades shares of any listed company
How much is minimum investment required to trade ETFs?
The minimum investment depends on the requirement of trading participants (brokers). Some trading participants (brokers) allow investments amounting to as low as Php5,000.
How do investors select which ETF to invest in?
The choice of the investor will depend on his investment objectives. Different ETFs can track different indices. In some markets, ETFs track sector-specific indices. For ETFs tracking the same index, an investor can base his decision on the capability of the ETF to closely track the index, as well as the general track record of the ETF company. Details and other information about an ETF are disclosed to the PSE and are available in both the websites of the ETF company and the PSE.
Do ETFs distribute dividends?
Just like stocks, the decision to distribute dividends depends on the company''s dividend policy or the decision of its board to do so.
What is the importance of posting the iNAV every minute?
The Indicative Net Asset Value, or iNAV, is an indication of the current net value of the ETF shares'' underlying securities and given on a per share basis. The iNAV is provided on a per minute basis during trading hours so as to timely guide investors on the movements of the ETF price vis-à-vis its underlying securities.
These two figures, the ETF share market price and the iNAV, give investors opportunities to arbitrage. Arbitrage is the almost simultaneous purchase and sale of similar or identical assets in order to profit from a difference in prices.
What is the importance of NAV?
An ETF''s Net Asset Value (NAV) is calculated and available at the end of trading day and gives a view on the size and performance of the fund. Creation and redemption of ETF shares are based on NAV.
What is tracking error and why is it important?
Tracking error is a measure of how well the ETF is able to track the index. A lower value indicates better performance of the fund. The tracking error is the standard deviation of the difference in relative returns between the ETF and its underlying index. A number of factors may cause the tracking error to increase, such as: the composition of the underlying assets, the fund''s cash component, dividends and expenses such as management fees. ETFs have to disclose the maximum level of tracking error in its prospectus.
How does the creation and redemption process work?
ETF processes involving creation and redemption of shares can occur any time during trading hours. In the creation, the trading participant authorized by the ETF Company, called the Authorized Participant, surrenders the underlying shares to ETF Company and in return, the ETF Company gives equivalent ETF shares in Creation Units to Authorized Participant. In general, Creation is undertaken when the relative value of the underlying shares (as evidenced by the iNAV) is cheaper than the ETF shares. Thus, participants can buy relatively lower priced underlying shares and exchange them for ETF shares which may be trading at a premium.
Steps in Creation
Step 1 - Request for creation: Cross transaction done through PSE, where Authorized Participant surrenders underlying shares to the ETF Company in exchange for ETF shares.
Step 2 - The Authorized Participant surrenders underlying shares to the Custodian.
Step 3 - The Custodian confirms availability of underlying shares.
Step 4 - ETF Company instructs the Transfer Agent that ETF shares can be issued.
Step 5 - Transfer Agent performs book entry movement of new ETF shares to be issued to the Authorized Participant.
Redemption is simply the reverse. The Authorized Participant surrenders ETF shares to the ETF Company in exchange for the corresponding underlying shares. This is undertaken when the ETF shares price is relatively cheaper than the value of the underlying shares.
KEY PARTIES TO AN ETF
- ETF Company - The ETF company must be established under the Investment Company Act and registered with SEC with a minimum capital of P250 Million. SEC requires it to have an all Filipino Board. Being a corporation, major changes in investment policies will require stockholders'' approval.
- Fund Manager - The ETF must engage the services of a reputable Fund Manager to operate and administer the ETF. Among the key tasks of the fund manager is to provide the composition of the ETF basket that will replicate the performance of the index it is tracking, set the tracking error and to also ensure that the tracking error is minimized. Both PSE and SEC impose a track record requirement for the Fund Manager.
- Authorized Participant - Authorized Participants are trading participants who are appointed by the ETF Company to undertake requests for creation and redemption of ETF shares. Each ETF must have at least two authorized participants, each with at least P100Million paid-up capital.
- Custodian - The custodian bank safekeeps the assets of the ETF, and is the party who confirms that the underlying shares have been deposited under its custody. These are usually the banks or non - banking institutions with a trust licence.
- Transfer Agent - Transfer agents are appointed by the ETF to maintain accurate registry of the initial and subsequent transfer of ETF shares. It must be a registered transfer agent with a minimum paid in capitalization of P100Million.
- How are ETFs traded? Just like stocks, ETFs can be bought and sold during trading hours, through the trading participants.
- How much is minimum investment required to trade ETFs? The minimum investment depends on the requirement of trading participants. Some trading participants allow investments amounting to as low as Php5,000.
- Can I surrender shares in my portfolio in exchange for ETF shares? Investors that can supply the minimum number of underlying shares required to form a creation unit can exchange such shares for ETF shares.
- How do investors select which ETF to invest in? The choice of the investor will depend on his objective. Different ETFs can track different indices. In some markets, ETFs track sector specific indices. For ETFs tracking the same index, an investor can base their decision on the capability of the ETF to closely track the index and the general track record of the ETF company. Details and other information about an ETF is disclosed to the PSE and is available in the website of the ETF company or the PSE website.
- Do ETFs distribute dividends? Just like stocks, the decision to distribute dividends depends on the company''s dividend policy of the decision of its management to do so.
- What is the importance of posting the iNAV every minute? The iNAV is an indication of the current value of the ETF shares'' underlying securities and given on a per share basis. These two figures, the ETF share price and the iNAV, give investors opportunities to arbitrage. The iNAV is provided on a per minute basis so as to timely guide investors on the movements of the ETF price vis-à-vis its underlying securities.
- What is the importance of calculating the NAV? An ETF''s Net Asset Value (NAV) is available at the end of trading day and gives a view on the size and performance of the fund. Creation and redemption of ETF shares are based on NAV.
- What is tracking error and why is it important? Tracking error is the standard deviation of the difference in relative returns between the ETF and its underlying index. The fund must minimize its tracking error, as it is an indication of how well the fund tracks the index. A number of factors may cause the tracking error to increase, such as: the composition of the underlying assets, the fund''s cash component, dividends and expenses such as management fees. ETFs have to disclose the maximum level of their tracking error in their prospectus.
- How is arbitrage performed in ETFs? Arbitrage is performed to minimize the potential deviation between the market price and NAVps or iNAV. Since the ETF process allows for the creation and redemption process between the underlying shares and the ETF shares, any gap between the share price and the NAVps should decrease when market participants undertake creation and redemption.
- How does the creation and redemption process work? In the creation, the Authorized Participant surrenders the underlying shares to ETF Company and in return, the ETF Company gives equivalent ETF shares to Authorized Participant. Creation is undertaken in general, when the relative value of the underlying shares is cheaper than the ETF shares. Participants can buy relatively lower priced underlying shares and exchange them for ETF shares which may be trading at a premium.
- What is the role of the ETF Market Maker? The ETF Market Maker is an Authorized Participant who is tasked to provide liquidity for ETFs. They are required to post bid and ask offers most of the time during trading. Its obligations are laid out in Part C of the ETF Market Making Rules and its Implementing Guidelines.
Redemption is simply the reverse. The Authorized Participant buys ETF shares which are then surrendered to the ETF Company in exchange for the corresponding underlying shares. This is undertaken when the ETF shares price is relatively cheaper than the value of the underlying shares.
