What is an Exchange Traded Fund (“ETF”)?
An ETF is a basket or portfolio of securities, much like a mutual fund or pooled fund, but with the additional advantage that it is listed and traded on an exchange, like a stock. This means that investors can buy or sell the fund continuously throughout the day, unlike traditional mutual funds which can only be bought or sold once a day.
Until recently, virtually all ETFs pursued index strategies (often referred to as passive investing) – tracking a specified index such as the S&P/TSX 60 Index or the S&P 500 Index. Today, ETFs follow a variety of strategies, both passive and active, and provide access to more geographic regions, sectors and asset classes than ever before. With access to over 3000 ETFs globally, HAHN adds value to the portfolio management process by carefully screening and effectively combining the best ETFs available globally into its strategies.
How is an ETF Created?
Like a mutual fund, an ETF is a legal entity, usually either a unit trust or an investment company, with a fund manager paid a fee to run and invest the fund according to its stated investment objectives. As with a mutual fund, the securities in the ETF portfolio are held in safekeeping with a custodian.
The creation of an ETF begins when the fund manager files a prospectus with securities regulators. The prospectus outlines important features of the fund for prospective investors, most notably its investment strategy, which for passive funds is the replication of a specific market index in order to deliver index returns.
Once the fund is approved by the securities regulator, ETF units can be “created” or “redeemed” by an approved underwriter at any time. A designated investment dealer, known as a market maker, delivers a basket of securities to the fund’s custodian that replicates the chosen index strategy. In return, the market maker receives ETF creation units which are then released into the secondary market at a price equal to the net asset value (NAV) per unit of the underlying basket.
Subsequently, units trade on the exchange at a price determined by supply and demand in the market. Market makers continuously function in the market, buying or redeeming baskets as necessary to ensure liquidity is maintained and that the market price of the ETF units trades close to the NAV of the underlying basket. This liquidity is an important feature of ETFs and a key reason why HAHN uses ETFs to build actively managed, global portfolios.