Exchange-traded funds (ETF) – A simple guide to how they work
What is an ETF?
ETF stands for "Exchange Traded Fund". An exchange-traded fund is an fund that is traded on the stock exchange, much like a stock. ETF and “exchange-traded fund” are used synonymously.
ETFs have the same distribution of risk as a traditional fund, but there are some important differences.
The difference between an ETF and a traditional fund
ETFs are traded and priced in real time on the stock exchange
The primary difference between an ETF and a traditional fund is that an ETF is traded over the stock exchange. This means that the price is set and can be purchased or sold in real time, in the same way as a stock. As the price in the underlying assets of the ETF changes during the day, the price of the ETF will also change. Depending on when you place your order during the day, the set price will be calculated at the exact time the order is executed. As an investor, this gives you the opportunity to sell directly when there is significant market volatility or to purchase and sell in the same day.
In contrast, the pricing for traditional funds is calculated only once each day. As a result, it does not matter when the order is submitted, since all of the orders will receive the pricing (NAV) that is set at the time of the fund’s valuation.
ETFs have low fees
Many ETFs are also known for their low management fees. One reason is that they are most often index funds. With index funds, the fund manager does not need to take any active investment decisions and, instead, invests in the assets, and in the unit, that is stated in the index tracked by the fund. Consequently, ETFs can be managed at a lower cost than a traditional actively-managed fund.
ETFs are transparent and predictable
ETFs are characterised by transparency and predictability. Since the vast majority of ETFs are index funds, there usually are no surprises. An ETF moves just like the market it is tracking. As a result, you can benefit from using ETFs as easy and inexpensive building blocks for creating your investment portfolio.
This is how Xact Bull & Bear work
A leveraged product is an investment that enhances the growth of an underlying asset over a specified period of time. This enhancement is called the leverage factor, which can be 1.5, 2.0, etc. The leverage factor can be both positive and negative.
Xact has ETFs with leverage that are designated as Xact Bull and Xact Bear. Leveraged ETFs are suitable if you firmly believe that the market is moving in a certain direction – irrespective of whether you believe in a upturn or a downturn. With Bull, your investment increases in value when the market rises and with Bear, your investment increases in value when the market falls.
Leveraged products offer an opportunity for higher returns, but also have a higher risk. It is important to remember that the leverage in Xact’s Bull and Bear ETFs is calculated on a daily basis. There is a difference between a leverage that is calculated on a daily basis and one that is calculated over a longer period of time. Over an extended period, the return for Bull and Bear ETFs will not be the return for the entire period multiplied by the leverage factor; but rather, the result of the combined daily changes during the period.
A simple guide to Xact Bull
Xact’s Bull ETFs increase in value when the market rises. Xact has ETFs with leverage of 1.5 and 2 times the daily percentage change in the underlying market. It is important to remember that if the underlying market falls, the return in the ETF will also fall by this leverage factor.
We assume that you believe the Stockholm stock market will go up so you invest in Xact Bull 2 which tracks the OMXS30™ index with a daily double leverage. The leverage means that if the index rises by 2 percent in one day, the value of Xact Bull 2 will rise by approximately 4 percent. Conversely, if the index falls by 2 percent in one day, the value of Xact Bull 2 will decline by 4 percent on that same day.
A simple guide to Xact Bear
Xact’s Bear ETFs increase in value when the market falls. Xact has ETFs with inverse leverage of 1.5 or 2 times the daily percentage change in the underlying market. It is important to remember that if the underlying market rises, the return in the ETF will also decline by this leverage factor.
We assume that you believe the Stockholm stock market will fall so you invest in Xact Bear 2 which gives you twice the upturn as the daily percentage decline in the OMXS30™ index. If the index falls by 2 percent in one day, Xact Bear 2 will rise by approximately 4 percent that day. Conversely, if the index rises by 2 percent, the value of Xact Bear 2 will decline by approximately 4 percent on that same day.
The value of Xact Bull & Bear is determined by the daily change in the market.
The return in Xact’s leveraged ETFs is calculated on a daily basis.
If you invest the same amount of money in Xact Bull and Xact Bear in the same underlying asset and keep both investments for one day, they will become the mirror image of each other. However, if you keep them for a longer period, the ETFs will not perform at a steady upward or downward rate, respectively.
During periods where the underlying assets fluctuate in the same direction, the return in Xact Bull and Xact Bear, respectively, will be higher than 1.5 or 2 times the daily performance. In other words, there will be a compound interest effect.
During periods where the underlying assets rise and fall inconsistently with each other, the return in Xact Bull and Xact Bear, respectively, will be lower than 1.5 or 2 times the daily performance. In other words, this scenario generates a negative compound interest effect.
As a result, if a market has a clear trend, up or down, it is more positive to own leveraged products.
Historical yields are not a guarantee of future returns. The money you invest in a fund can both increase and decrease in value and it is not guaranteed that you will recover the entire invested amount. The complete information brochure, fund rules and fact sheets is available under each fund.
As easy as trading stocks
Investing in ETFs is easy. Fund units are bought and sold individually on the stock exchange, just like stocks. Trading with ETFs also has the same settlement schedule as stocks (transaction date plus 2 business days), which also makes ETFs well-suited in a portfolio consisting of individual stocks.
An order is placed for the number of ETF units to be bought or sold and the only requirement is a custody account, a Swedish VP account or an investment savings account (ISK). Fund units can also be registered at an IPS account or an insurance custodial account. When ETFs are bought and sold, a commission is paid to your broker in accordance with applicable pricing.
Market makers set prices
Xact has agreements with several independent market makers who set bid and ask prices during the entire trading day based on the value of the funds in real time. This means that you can buy and sell ETF units at any time during the opening hours of the stock exchange. In Sweden, Xact’s ETFs are traded on NASDAQ OMX Stockholm. We also have ETFs listed on Oslo Börs and Nasdaq OMX Copenhagen.
Liquidity and spread
An ETF reflects the performance of a specific market index or strategy. The market makers set prices for the ETF based on the price change in the underlying assets. Both liquidity and the difference between the bid and ask price (“spread”) are linked to the underlying assets in the ETF. For example, the spread is normally wider in a small cap ETF, compared to an ETF that tracks an index with only large caps. The liquidity and the spread in the ETFs can vary continuously intraday. However, the presence of the market makers means that there are liquidity and trading opportunities in ETFs even if there are a few number of trades in the ETFs.
Xact’s ETFs are not currency-hedged. This means that as an investor, you will have a currency exposure in the funds that have holdings listed in currencies that are not the same as the ETF’s trading currency.
An exchange-traded fund is a fund with fund units that are traded daily on the stock exchange, in the same manner as a stock. ETF is an acronym for Exchange Traded Fund, which is another term that is used for these types of funds.
Yes, legally and for tax purposes an ETF is a fund. Xact’s funds are under the supervision of the Swedish Financial Supervisory Authority.
ETFs were developed by US fund managers in the beginning of the 1990s and have revolutionised investment strategies. They are used by both institutional and private investors and are now one of the most popular financial instruments. Exchange-traded funds have been available in Europe since 2000, which was the same year that Xact listed the first ETF in Sweden.
Xact Bull and Xact Bear are the terms we use for our ETFs with leverage. Bull may be suitable for investors with a strong belief in positive performance on the stock market, while Bear provides the opportunity to earn money during a downward trend in the stock market. It is important to understand how these funds work before making an investment in one of these funds.
Exchange-traded funds provide you the opportunity to combine the advantage of a fund as related to the distribution of risk, with the advantage of a stock as related to trading. Instead of managing a large basket of stocks on your own, you can track the performance of the stock market through securities (ETFs). You can also use ETFs as a foundation in your portfolio and complement it with direct savings in stocks. ETFs are also suitable if you are interested in a simple and quick way to take advantage of the daily upward and downward movements of prices on the stock market.
With index management, the fund manager invests based on a pre-determined model, which is frequently a market index. Therefore, the returns on the index fund depend on which market, strategy, or more precisely, which index is tracked by the fund. Xact has funds that track a market index, such as Xact OMX, as well as funds that track an index that is determined and weighted based on other parameters, such as the company’s market value. An example of this is Xact Högutdelande, which focuses on companies with high dividend yields and low risk, where both the incoming companies and their weighting in the index is determined by these parameters. What distinguishes an index fund is that you know what you are buying. Your returns will be the market returns minus the management fees. In general, the management fees in index funds are lower, since index funds do not conduct any company analyses, but rather track an index.
The primary difference is that an exchange-traded fund, like a stock, is traded and priced in real time. Depending on when an order is placed during the day, the order will be settled at the price that is applicable at the time the order was executed. In contrast, a traditional fund is priced only once each day. In this case, it does not matter when fund units are purchased or sold during the day – one and the same price will apply regardless of when the order was placed.
To trade in ETFs you need a custody account, an IPS account or an insurance custodial account, a Swedish VP account or an investment savings account (ISK).
Costs consist of a commission and a management fee. When buying and selling an ETF, you will pay a commission fee to your broker as you would for any other stock. The management fee is between 0.10 percent and 0.80 percent of the fund value per year, depending on which fund you choose. The management fee is deducted from the fund unit’s value on a daily basis.
No. When trading with exchange-traded funds, an order is placed for the number of units you want to buy or sell, just like with stocks.
A trading unit for the funds listed on the Stockholm stock exchange is equivalent to one (1) unit. Thus, you can trade in as many units as you would like, i.e., 1, 47, 739, etc.
No. You may purchase and sell your fund units as many times as you would like during a trading day.
The fund units are traded on the stock exchange – as with stocks – through a bank or stockbroker. The funds are traded in the same manner as a stock. You can purchase and sell fund units as frequently as you would like - and when you would like – during a trading day under the condition that you have sufficient resources in your custody/bank account.
Appointed market makers are continuously quoting bid and offer prices based on the fund´s value in real time.
Trading starts at 09:00.30 with an opening auction and closes at 17:25 without a closing auction.
XACT Sverige and XACT Högutdelande pay cash dividends to unit holders. Other Sweden-registered funds reinvest all earnings in the fund.