An ETF, for exchange-traded fund, is an investment fund listed on a stock exchange. It holds a basket of assets and trades continuously, like an ordinary share. It has become one of the simplest and cheapest ways to invest in a diversified way.
1 What is an ETF?
A fund you buy and sell on the exchange, at any moment of the session.
Definition
A basket of assets, listed like a share
An ETF gathers many assets (equities, bonds, commodities, sometimes cryptocurrencies) into a single wrapper whose units trade on the exchange. Most ETFs are index funds: they aim to faithfully replicate a benchmark index, such as the CAC 40 or the S&P 500. Buying a unit of such an ETF therefore amounts to holding, in a single transaction, a fraction of the entire index.
2 How it works
An arbitrage mechanism keeps the price close to the real value of the basket.
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Replicating an index. The ETF holds the same securities as the index, in the same proportions, and so tracks its performance.
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Creation and redemption of units. Authorised intermediaries can create or destroy units in exchange for the underlying basket of assets, which adjusts supply to demand.
③
Arbitrage. If the ETF's price drifts from the value of its basket, these intermediaries step in to profit from the gap, which pulls the price back to fair value.
3 Strengths
Why they won investors over.
🧺Diversification
A single unit gives access to dozens or hundreds of securities.
💸Low fees
Passive management costs far less than an actively managed fund.
💧Liquidity
You buy and sell continuously, at the market price.
4 Limits
Diversified does not mean risk-free.
Points of caution
An ETF replicates its index on the way up as on the way down: it offers no protection against a market fall. Some ETFs, known as leveraged, inverse or synthetic, are markedly riskier and unsuited to long holding. Finally, the concentration of an index in a few very large stocks can reduce real diversification.
5 Takeaways
To remember in a few sentences.
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An ETF is an exchange-listed fund that holds a basket of assets.
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Most replicate an index, at low cost (passive management).
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Strengths: instant diversification, low costs, liquidity.
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Limits: it follows the market down too; beware leveraged or inverse versions.
This notion illuminates an analysis