How are ETFs regulated?
The vast majority of Europe-domiciled ETFs are organised and regulated as registered investment companies under the Undertakings for Collective Investments in Transferable Securities (UCITS) directive1.
This is the same regulatory regime that governs the UCITS mutual funds domiciled within the European Union.
While all investing involves risk, this framework provides various degrees of investor protection. These include ensuring underlying investments are liquid, portfolios are diversified, and assets are ring-fenced and held by a custodian.
1European Council Directive of 13 July 2009 (2009/65/EC) on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities and any amendment thereto.
What is the history of ETFs?
The world's first ETF was created in Canada in 1990, transforming the investment landscape and offering the advantages of pooled investing and trading flexibility.
In their early days, ETFs were used primarily by institutional investors to execute sophisticated trading strategies. However, it wasn't long before individual investors and financial advisers embraced ETFs.
Since their introduction, ETFs have grown to become one of the most popular products in the global investment industry. Today, global ETF assets total more than USD 7.3 trillion, invested in more than 7,500 ETFs and ETPs1.
ETF Milestones
1Source: ETFGI as at 30 November 2020.
2Source: ETFGI as at 31 December 2009.
Note: ETF assets and product data include exchange-traded funds and exchange-traded products (ETPs).
How do ETFs compare with mutual funds?
ETFs and mutual funds serve the same general purpose.
They provide exposure to particular markets or market segments. So it's not surprising that they share more similarities than differences.
Similarities between ETFs and mutual funds
Diversification
By pooling money from many investors, ETFs and mutual funds have greater buying power, enabling them to buy many different securities in large quantities. This results in greater diversification than an investor can achieve buying individual shares and bonds. ETFs, like mutual funds, can also provide diversified exposure to many segments of the market.
Regulation
The vast majority of Europe-domiciled ETFs are organised and regulated as registered investment companies under the Undertakings for Collective Investments in Transferable Securities (UCITS) directive1. This is the same regulatory regime that governs the UCITS mutual funds domiciled within the European Union.
1 European Council Directive of 13 July 2009 (2009/65/EC) on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities and any amendment thereto.
Transparency
Compared with actively managed funds, index ETFs and index mutual funds are extremely transparent. Investors generally know what the holdings are and in what proportion based upon the target index, particularly when a full replication strategy is used to track the index.
Differences between ETFs and mutual funds
Trading flexibility
Orders to buy or sell ETF shares are executed throughout the trading day at market-determined prices that change continually. ETFs can also be traded at the day’s calculated net asset value. By contrast, mutual fund shares may only be purchased or redeemed at their NAV, which is struck once a day. Typically this is the end-of-day price in the relevant market.
Costs
Both ETFs and mutual funds charge a total expense ratio (TER) (also known as the ongoing charges figure, or OCF) which essentially covers ongoing operating costs. But because ETFs trade on exchanges, they also have unique costs not associated with mutual funds, such as broker commissions and bid-ask spreads.
| ETFs | Mutual funds | |
|---|---|---|
| Access | Shares bought and sold on an exchange or over the counter through a stockbroker, platform offering brokerage services, or a market maker. | Shares bought and sold directly through the fund company or through a fund distributor. |
| Pricing | Share prices set by the market throughout the trading day; net asset value based on official closing prices. | Net asset values determined once per trading day, based on official closing prices, after financial markets close. |
| Minumum trade size | One share | Fractions |
| Transaction costs | Brokerage commissions and bid-ask spreads on each direct purchase and sale. | Sales charge (for most funds), entry/exit charges or swing prices. |
How can ETFs be used?
ETFs can be used to implement a variety of short and long-term investment strategies.
Some of the uses for ETFs are strategic – for example, asset allocation – while others are tactical. Whether it makes sense to use ETFs in a particular strategy depends on a number of factors, including the amount invested, holding period, trading costs, appetite for risk and more.
Here are some of the most common ways investors put ETFs to work in their portfolios:
