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ETF: What is an Exchange-Traded Fund?



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Exchange-Traded Funds (ETFs) have emerged as a significant investment vehicle in the global financial markets. These funds provide flexible tools for portfolio creation, risk management, and tactical asset allocation. These tools effectively access multiple asset classes and support complex investment techniques to enhance portfolio performance.

Basics of ETFs

What is an ETF?

An Exchange-Traded Fund (ETF) is an investment fund that is traded on stock exchanges throughout the day, like individual stocks. ETFs hold a collection of assets—such as stocks, bonds, commodities, or a mix of these assets—and are designed to track the performance of a specific index, sector, commodity, or asset class.

One unique feature of ETFs is the creation and redemption process. Large financial institutions known as Authorized Participants (APs) can create or redeem ETF shares in large blocks known as creation units.

This mechanism helps keep the market price of ETFs aligned with their net asset value (NAV) through arbitrage opportunities. Understanding this process is important for financial professionals as it enhances the tax efficiency of ETFs and minimizes capital gains distributions, which can affect client portfolios.