An Exchange Traded Fund (ETF) is an open-ended investment fund that trades on exchanges like a stock, typically tracking an index or basket of assets.
How ETFs Work
ETFs combine features of mutual funds and stocks. They hold portfolios of assets but trade continuously during market hours at prices determined by supply and demand. An arbitrage mechanism keeps market prices aligned with the underlying net asset value through authorised participants who can create or redeem large blocks of shares.
Common ETF Types
| Type | Description | Example Focus |
|---|---|---|
| Equity | Tracks stock market indices | FTSE 100, S&P 500, MSCI World |
| Bond | Fixed income exposure | Government gilts, corporate bonds |
| Commodity | Physical or futures-based | Gold, oil, agriculture |
| Sector | Industry-specific | Technology, healthcare, financials |
| Smart Beta | Alternative weighting | Low volatility, dividend, factor-based |
UK Market Characteristics
ETFs on the LSE have distinct identifiers:
- TIDMs often end in numbers or specific codes
- Multiple share classes in GBP, USD, or EUR
- UCITS-compliant for investor protection
- Continuous market maker liquidity
ETF vs Investment Trust
| Feature | ETF | Investment Trust |
|---|---|---|
| Structure | Open-ended | Closed-ended |
| Share creation | Created/destroyed on demand | Fixed shares |
| Trading vs NAV | Close to NAV (arbitrage) | Can trade at premium/discount |
| Gearing | Rarely employed | Commonly used |
| Management | Usually passive | Active or passive |