An Exchange Traded Fund (ETF) is a security and investment vehicle that has attributes of both mutual funds and stocks. Like traditional mutual funds, ETFs enable investors to access a diversified pool of assets. Like stocks – and unlike traditional mutual funds - ETFs trade throughout normal trading hours on an exchange.
ETFs offer several benefits that may make them an attractive alternative to mutual funds. As with all other investment decisions, investors should seek their own financial, legal and tax advice prior to purchasing any securities.
At its most basic level, owning an ETF is like owning a single stock that represents a basket of securities. As such, the ETF provides access and exposure to most major asset classes, including equities, fixed income, commodities and currencies. The simplest ETFs are designed to replicate to the greatest extent possible and “passively” track the performance of an underlying index or benchmark. The index constituents – the basket – can be equities, bonds, futures contracts or a mix of different asset classes.
There are many different types of indices and it is important to understand how each is constructed.
ETFs have evolved over recent years to include those that do not track an underlying index or benchmark. Some are physically backed by commodities, while others are “actively managed” with the objective of providing above-benchmark returns or incorporating sophisticated “alternative” investment strategies. Rather than merely seeking to passively track an index, these types of ETFs try to achieve a specified investment objective using an active investment strategy. In some cases, these investment strategies are built into “customized” indices.
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