What if ETFs, exchange-traded funds, index funds, passive investing… what does all this mean? Why are ETFs on the lips of all traders? We explain what they are, what is special about them, how to buy them and much more.
What is an ETF?
An ETF (Exchange Traded Fund or exchange-traded fund) is basically , like an investment fund, a basket of shares that are publicly traded .
However, this basket is not made up of shares of several companies selected directly by a manager, but rather exactly replicates or copies the behavior of an index, a market sector or a geographical area .
For example: an ETF of the ibex35 will reproduce exactly the behavior of this index. So if the 35 Spanish companies go up and therefore the Ibex, the ETF that replicates it will also go up.
This is so because the value of the ETF is the result of the sum of the shares that compose it (in their proportion), that is, if Telefónica and Endesa go down, the ETF will reproduce this movement and also decrease its price.
Difference between an ETF and a mutual fund
The biggest difference with a mutual fund is that you can buy an ETF on the stock market, since they trade the same as a stock. Hence, they are often referred to as hybrids between mutual funds and stocks.
In fact there is no minimum investment, you can buy an ETF directly through your broker, without having to go to the fund manager and at any time during the session.
Active vs passive investment
You will often come across the term “passive investing” in reference to ETFs and exchange-traded funds, but what exactly does this mean and how is it different from “active investing”?
When we speak of active investment, we refer to portfolios of stocks that have been specifically selected by a management team that analyzes the companies directly and the macroeconomic situation . With this information they buy and manage assets in the proportion they estimate, hence these portfolios are not restricted to a geographic area or economic sector.
On the contrary, passive investment is known as those portfolios made up of shares that replicate an index , that is, they copy its behavior. Since a large team of analysts is not needed for its management, the management costs are lower than in active management.
What is a replica?
We have just seen that an ETF is characterized by exactly replicating or reproducing the behavior of an index. This replica can be of two types:
- Physical replica : the ETF buys all or a representative part of the shares of the index that it replicates, to copy their exact movement . In other words, an ETF that physically replicates the DAX will have the same proportion of shares of the 30 companies that make up the index.So far easy, however there are too large indices that can contain more than 1,000 securities of small companies and with little liquidity. This is where synthetic replicas come into play.
- Synthetic replication : thanks to swaps (financial swap contracts), ETFs are able to reproduce the value of the index with great accuracy but without the need to buy it (since they are based on a future exchange), and that they could not be physically reproduced without incurring at huge costs.Unlike physical ETFs, synthetics also do not consider dividends on the curve of their replica.