What are Exchange Traded Funds (ETFs)?
ETFs are open-ended funds that are listed and traded on a stock exchange, and can be bought or sold directly during trading hours, much like a stock. They typically represent a basket of securities which may consist of stocks, bonds, or other assets such as commodities. ETFs can offer many benefits to investors, including diversification, liquidity, cost effectiveness, transparency and tax efficiency.
Benefits of an ETF
ETFs provide investors with the ability to invest in an entire market index which could cover a broad range of asset classes, sectors and geographies. This enables investors to spread their investment and reduce risk compared with investing in single stocks.
ETFs are traded on a stock exchange much like a stock, they can be traded throughout the day when the stock market is open.
ETFs generally have lower costs associated with them than other investment solutions.
Investing in an ETF means that investors will know exactly what they are invested in. Investors have daily visibility as to what is held within the ETF through the portfolio composition file, how the ETF is performing and its associated costs provide this transparency to the investor.
ETFs provide the potential for relatively lower capital gains tax liabilities than other investment products.
Risks associated with an ETF
As with all investment vehicles there are also associated risks when investing in and ETF and an investors initial investment and any income from it is subject to market fluctuations and your initial investment is not guaranteed.
There is no guarantee that past performance can provide investors with a guide to the ETFs future performance and this should not be the only factor to consider when considering investing in an ETF.
When buying and selling and ETF, an investor needs to consider the brokerage fees that will apply and also be aware that liquidity is not guaranteed.
For more information about any of the terms contained in this page please refer to our ETF FAQs & Glossary page.
Liquidity is one of the key benefits of ETFs
ETFs are listed on stock exchanges and – like stocks – can be bought and sold during normal trading hours through a broker.
ETFs offer a unique dual source of liquidity:
- Primary Market Activity: On-screen ETF liquidity is reinforced by an efficient over-the-counter creation and redemption process of fund units, also known as the Primary Market. Authorised Participants (APs) work in partnership with BMO to supply or remove liquidity on-demand from the market. Particularly for larger size orders, the creation/redemption process offers an efficient alternative to access further market depth.
- Secondary Market Activity: Traditional on-exchange order book trading is supported by dedicated Market Makers providing two-way prices throughout the day.
On-exchange trades are centrally cleared, removing bilateral counterparty risk.
The creation/redemption process reflects the liquidity of the underlying basket holdings. The ETF is as liquid as the individual index components.
Arbitrage opportunities arise when the price of the ETFs moves significantly away from the bid-ask spread of the underlying basket of securities introducing premiums and discounts vs. the ETF net asset value (NAV). The creation/redemption mechanism allows APs to bring the ETF price closer to its fair value.