Straight answers to the questions investors ask most often about ETFs; from how they trade to what keeps prices in line with the value of the underlying portfolio.
An ETF, or exchange-traded fund, is a pooled investment fund whose shares trade on a stock exchange throughout the day. It combines features of both mutual funds and shares: diversified exposure in a single vehicle, with the ability to buy and sell during market hours.
The biggest difference is how it trades. ETF shares are bought and sold on exchange during the day at market prices, while traditional mutual funds are typically dealt at end-of-day net asset value. ETFs also tend to offer greater day-to-day visibility on holdings and pricing.
No. Many ETFs track an index, but not all do. Some are actively managed, which means the portfolio manager makes ongoing investment decisions rather than simply following a benchmark.
An active ETF is an exchange-traded fund in which the portfolio is managed using investment judgement, rather than simply tracking an index mechanically, in order to achieve the stated investment objective. It still offers the familiar features of the ETF structure – exchange trading, intraday pricing and generally high transparency – but the holdings are selected or adjusted in line with the manager’s process and objectives. Active ETFs have historically been a smaller part of the market than index ETFs, but they use the same core ETF structure.
An index ETF is designed to follow a benchmark. An active ETF gives the manager more freedom to respond to changing risks, valuation differences or portfolio objectives. That can be useful when investors want more than simple market exposure alone. The trade-off is that outcomes depend more heavily on manager skill, judgement and process, and fees may be higher than for straightforward index-tracking ETFs.
Investors buy and sell ETFs through a broker, platform or advisory account, just as they would buy and sell listed shares. Retail investors generally trade ETF shares on exchange rather than dealing directly with the fund itself.
NAV stands for net asset value. In simple terms, it is the underlying value of the ETF’s portfolio. It is a reference point for what the fund is worth, while the market price is the level at which ETF shares are actually trading on exchange.
Because ETFs trade on exchange, their market price is shaped by supply and demand. Small gaps can open up between price and underlying value, but portfolio transparency plus the create/redeem mechanism usually help keep those gaps relatively short-lived.
An authorised participant, or AP, is typically a large financial institution that can create and redeem ETF shares directly with the fund. APs are central to the ETF structure because they help add or remove shares in response to demand in the market.
A market maker is a firm that provides ongoing buy and sell quotes for an ETF on exchange. Market makers support secondary-market trading and liquidity. They are not the same as authorised participants, although some firms can perform both roles.
No. Screen volume is only part of the picture. ETF liquidity has two layers: the liquidity of the ETF itself on exchange, and the liquidity of the underlying securities or instruments it holds. That is why an ETF is likely to be more liquid than its visible trading volume suggests.
Often, yes. One of the attractions of ETFs is transparency. Most ETFs disclose their holdings daily, which helps investors see what they own and allows the market to compare the ETF price with the value of the underlying portfolio.
Do not stop at the headline fee. Ongoing charges matter, but so do trading costs such as the bid-offer spread and, in some cases, premiums or discounts to NAV. For index ETFs, it is also worth looking at how consistently the fund has tracked its benchmark in practice.
Tracking error is a way of describing how closely an index ETF follows its benchmark over time. In broad terms, the lower and more consistent it is, the more precisely the ETF has delivered the index exposure investors expected.
This is a key difference between passive and active management. Passive strategies typically seek to minimise tracking error, as their objective is to mirror the benchmark as closely as possible. Active managers, however, may deliberately run a higher or targeted level of tracking error, using the benchmark more as a reference point than a portfolio blueprint.
ETFs are investment funds, so they still carry market risk. Beyond that, the risks depend on what the ETF holds and how it is built. More complex ETFs – especially those using derivatives, leverage, inverse exposure or specialist assets – may introduce additional counterparty, liquidity or structural risks.
No. ETFs can be used in different ways. Some investors use them tactically, but they are most commonly used as long-term building blocks for diversified portfolios and efficient market access, similar to traditional mutual funds.
No. ETFs sit within a broader exchange-traded universe, but not all exchange-traded products have the same structure or risk profile. Some can be more complex, particularly those offering leveraged or inverse exposure. It is worth checking exactly what kind of product you are looking at before investing.
