So much has been said and done in the world of trade due to continuous developments followed by crucial law enforcement by government authorities that the dynamics of the financial industry have flipped upside down. Many key factors have contributed in this much needed wave of change, one of which is the introduction of exchange traded funds (ETFs).
As refreshing as it sounds, it still is essential to know what an ETF basically is and how it functions. Thus, an ETF is a marketable security that holds investments and keeps track of assets like stocks, commodities, bonds, etc. In short, ETFs are funds that are similar to mutual funds but they trade like stocks. Most of the exchange traded funds invest in stocks but there are some which invest in other types of assets such as, currencies, bonds, commodities, etc. An ETF also helps divide the ownership of an asset into multiple shares. Some of the most commonly traded ETFs around the globe are SPDR S&P 500 Index (SPY), iShares Russell 2000 (IWM), Invesco QQQ (QQQ), SPDR Dow Jones Industrial Average (DIA), etc.
A very simple question that arises in the minds of investors is whether an ETF has a prospectus or not, the answer to that question is quite simple as explained by the U.S. Securities and Exchange Commission (SEC):
An ETF will also have a prospectus, and some ETFs may have a summary prospectus, both of which are subject to the same legal requirements as mutual fund prospectuses and summary prospectuses. All ETFs are required to deliver a prospectus upon request and without charge, and the prospectus will usually be available on the ETF’s website.
The thought of an ETF prospectus might sound intimidating at first but once you get in depth of its abilities, you come to know that it actually contains valuable information that may prove fruitful for investors, giving them an insight on the investment objective, fee table, key risks and financial highlights information. This helps them gain knowledge of an ETF from identifying its objectives to analyzing its past financial performance, also containing the risks and fees involved in acquiring the ETF. Hence, ETFs do have prospectuses that hold handy information directed to investors.
Considering the functions of an ETF and its ability to be traded like stocks, many would say that investing in an ETF is the sound choice, however, there are certain flaws entitled to an ETF which must be taken into consideration by investors. The biggest advantage of an ETF is its tradable capability which may also be a disadvantage in itself, as whenever a stock is bought or sold, a commission fee is paid for that particular stock. Similar is the case with exchange traded funds, on every transaction of an ETF, an additional trading fee is paid unlike mutual funds, for which one does not have to pay any sort of additional fee.
Underlying fluctuation is another flaw, volatility can impact an ETF even one with several underlying positions. An ETF that traces a broad index like the S&P 500 will probably be less volatile than one that tracks a specific industry like the oil industry. It is important to know what the ETF is tracking and the risks involved and with an international ETF, know the fundamentals and credit worthiness of the country it’s following.
Thinly traded ETFs pose liquidity problems. If there is a large spread between bid and ask, then the ETF is probably illiquid. When considering an ETF, investors must study its spread and market movements over at least a month. Sometimes, ETFs distribute capital gains which is not always what shareholders want because of the tax liability. It is usually better when ETFs retain capital gains and invest them instead of distributing them. Also, it is better to buy an ETF with a lump sum rather than through dollar cost averaging. Buying an ETF with one lump sum means only one commission charge whereas, dollar cost averaging normally results in several.
Hence, before making an ETF investment, the above mentioned flaws must be taken into notice to decide whether investing in an ETF is the better option or not.
Investing in ETFs
A perfect investment is merely a myth as everything that can be traded has its pros and cons and ETFs have their flaws too but the exchange traded funds do stand out from stocks as they are considered to be “a cost-effective way of achieving a broadly-diversified portfolio including hard-to-own (but worthwhile) assets”, making them the better investment opportunity as compared to stocks. These abilities of an ETF can be a source of attraction for many investors which gives them lead on why they should invest in ETFs and if they are worth buying. The simplest answer is the simplest question, why not? ETFs are worthy of trading because they are more appealing to investors with more hands-on investment styles, those seeking higher short-term returns on investments and the ones who desire greater access to alternative investments such as the Forex market and futures.
What investors are most concerned about is whether an ETF gives out dividends or not. Well good news, it does pay full dividend that is incurred with a share held within the funds. The dividends on an ETF are paid out quarterly on a dividend per share basis to shareholders. There are two types of dividends which are paid to shareholders; qualified and unqualified dividends. It is a compulsion for the ETF issuers to pay out dividends from the securities held in their funds.
Furthermore, most of the ETFs are indexed funds which means they are funds that invest in exactly same securities as that given in a year like the S&P 500 Index. This type of ETF is fairly safe however, a new breed of ETF has evolved which is ought to be riskier than indexed ETF, which is leveraged ETF. A leveraged ETF uses debt to increase the magnitude of profits which also increases the level of risk, making indexed ETFs the safer investment.
ETFs & Mutual Funds
ETFs are similar to mutual funds, both gather securities to offer investors a wide range of portfolios but they are not exactly the same. These two type of funds function differently from one another, for example; ETFs are traded all day just like stocks whereas the mutual funds only trade at the end of the day at the net asset value (NAV) price. ETFs which track on a certain index have lower operating expenses as compared to mutual funds which also means that they (ETFs) may give a better rate of return on investments. ETFs do not have any sales loads or investment minimums whereas mutual funds mostly have both however, ETFs have additional trading fee on every transaction throughout the day but mutual funds do not incur any additional fee. Thus, these are the major differences between exchange traded funds and mutual funds which are often confused to be alike but in reality, are not.
There has been a massive and noticeable evolution of the blockchain technology in the world of trade and inevitably, blockchain ETFs had to come into existence. Yes, blockchain ETF is a thing!
Blockchain ETFs are the type of funds that operate in blockchain related companies or the companies that hold investments or gather profits from blockchain-based companies. Some prime examples of blockchain ETFs are Amplify Transformational Data Sharing ETF, Reality Shares Nasdaq NexGen Economy ETF, First Trust Indxx Innovative Transaction & Process ETF, Innovation Shares NextGen Protocol ETF, REX BKCM ETF and more.
You would guess that following the introduction of blockchain ETFs, cryptocurrency ETFs will soon be launched and if you thought so, you were right to some extent as attempts to launch bitcoin ETFs have been made by several exchanges however, as reported a few days ago, the bitcoin ETFs have not been able to fall on the criteria set by government authorities and as it stands, no cryptocurrency ETF is expected to launch any time soon but constant efforts are being made by various organizations to introduce a bitcoin ETF.
What really is a bitcoin ETF? It is a fund that intimates the price of bitcoin which would allow investors to buy an exchange traded fund without going through the pain that a normal cryptocurrency investor goes through on regular basis and the investor will not have to worry about the risks and security issues involved with holding the cryptocurrencies.
To launch a bitcoin ETF, it is necessary to fall on the criteria set by the U.S. Securities and Exchange Commission (SEC) which holds the responsibility to allow the introduction of ETFs and their regulation. Unfortunately, the SEC has not approved any bitcoin ETF yet due to the inability of exchanges to meet the standards set by the government authority. The SEC intends to regulate the digital assets and that they will have to register with the SEC for thorough supervision, which obviously is not admired by the digital assets. Certain regulatory policies have been implemented by the SEC on the introduction of bitcoin ETFs which will have to be obliged even after the launch of those ETFs, if that is to happen sooner or later.
Is bitcoin a security itself? Considering the market dynamics and recent events, the answer is no. As regulatory authorities in the crypto world have been prompted to take crucial steps in this regard following the numerous hacks and illicit events in the crypto market, bitcoin cannot be considered as a safe investment. We notice a drastic decrease in the cryptocurrency’s price in over a period of one year from over $19,000 in December 2017 to merely $3,300, which proves why the cryptocurrency cannot be considered a safe investment at this point in time.
Bitcoin; Token or Commodity
Although bitcoin is not a token but it is a commodity that is used for trading purposes and is an operating asset that has a certain value. Tokens do not simply act as a currency like BTC does, they do have value too but they are hosted on another blockchain which are made by using the core coin. Thus, bitcoin is a digital currency used as a commodity and not as a token. To trade bitcoins, bitcoin exchanges come into role which act as an intermediary between buyers and sellers where fiat currencies and altcoins are used for purchases.
A different type of token is a security token, also known as an authorization token, is a small hardware device owned to authorize access to a network service. The authorization token or security token provides a two-factor authentication before logging in a user which provides more security to the user. It may be in the form of a small card or might be embedded in an object and is easy to carry. Even if the security token is misplaced or stolen, it cannot be accessed due to the addition of a two-factor authentication, which only the real user can log in through after providing the correct required information.
ICO is not an IPO
Another confusion existing in the world of trade is whether an initial coin offering (ICO) is a security and according to Mr. Jay Clayton, Chairman of U.S. Securities and Exchange Commission, an ICO is not really a security whereas an IPO is. He believes that similar to the case of currencies, where digital currencies are presumably to replace fiat currencies but are not secured like the fiat currencies, ICOs are thought to replace the IPOs but they are also not securities like IPOs are. This information makes the confusion somewhat clear that an ICO might have similar functionalities but not exactly the same after all.
A new world of trade has evolved and the amount of factors that have contributed in it is beyond count but the prime factor is technology which has brought countless innovations and further developments followed and the only thing constant is the fact that there is no full stop to these developments as we should expect a lot more to come.