What Are Exchange-Traded Funds (ETFs)?

What are exchange-traded products?
Exchange-Traded products (ETPs) at their core are securities which derive their value from a basket of securities such as stocks, bonds, commodities or indices, and are traded similar to individual stocks on an exchange. When you purchase an ETP, you are purchasing shares of the overall portfolio, not the actual shares of the underlying investments or index components. ETPs can track a wide variety of sector-specific, country-specific and broad-market indexes. ETPs may provide diversification to your overall portfolio because one share or one unit may represent multiple underlying stocks, bonds and/or other asset classes.

Each ETP seeks to track the market performance of the underlying index that makes up its basket of securities. Although ETPs seek to mirror the performance of a particular index, the relationship between performance of the index or sector and the ETP is not exact because of the fees and trading costs associated with the ETP, as well as the difficulties in exactly mimicking an index.

Features and characteristics

Some key features and characteristics associated with ETPs include:

Tax efficiency - Traditional ETPs are generally not actively managed and, as a result, typically generate fewer capital gains due to the low turnover of the securities within their portfolio. Taxes must be paid on all distributions made by the underlying securities and any capital gains associated with transactions made by the fund. However, because ETPs offer in-kind redemptions to qualified entities, they can avoid realizing capital gains for the fund although shareholders must still pay any taxes on realized gains. Nontraditional ETPs may not be tax efficient due to the increased amount of portfolio turnover due to periodic rebalancing as well as the use of leverage. If you have questions about the possible tax consequences associated with these funds, you should consult your tax advisor before making any investment decision.

Expense ratios - Nontraditional ETPs will generally have higher fees than traditional ETPs. Associated charges may include management, interest and transaction fees. The management fees are charged by the fund management company, which cover both marketing and fund administration costs. Interest and transaction fees are costs related to holding and transacting in derivatives securities and are generally built into the pricing. Purchases and sales of ETPs are subject to brokerage commissions. All fees and expenses are described in detail in the prospectus.

Transparency - The securities in most ETP portfolios are made public every day. Since these securities generally trade within an index or sector that the ETP follows, you may be able to determine the positions within the portfolio at any time. You may find this beneficial because the transparency could allow you to have more control over your overall investment portfolio allocation and weightings.

Portfolio diversification (access to wide range of sectors) - ETP portfolios can be diversified across many different securities, offering a set of portfolios for almost every asset allocation need. This diversification can help reduce an investor’s risk by potentially offsetting losses from some securities with gains in others. Bear in mind, diversification cannot guarantee a profit or protect against loss in a declining market.

Buying and selling flexibility - ETPs are priced and can be purchased and sold throughout the trading day. Furthermore, you can buy or sell ETP shares on a stock exchange much like the purchase or sale of any other listed stock. 

Exchange Traded Products are subject to risks similar to those of stocks. Investment returns may fluctuate and are subject to market volatility, so that an investor's shares, when redeemed or sold, may be worth more or less than their original cost. Exchange Traded Funds seek investment results that, before expenses, generally correspond to the price and yield of a particular index. There is no assurance that the price and yield performance of the index can be fully matched.  
Until recently, traditional ETPs have generally not been actively managed. This means that securities in the portfolio will not be purchased or sold in an attempt to take advantage of changing market conditions. A traditional ETP may continue to hold securities even though their market value and dividend yields may have changed. An ETP generally carries the same investment risk as the portfolio of securities that comprises the index tracked within the ETP. Securities in a portfolio may depreciate, and the ETP may not achieve its intended objective. In addition, each ETP is subject to specific risks that vary depending on each ETP’s investment objectives and portfolio composition