Traditional exchange-traded funds (ETFs) are available in hundreds of varieties, following nearly every index can think of.
Passive ETF investing
ETFs were originally created to provide a single security that tracks an index and trades intraday. Intraday trading lets investors to buy and sell, in essence, all of the securities that make up the whole market (like the S&P 500 or the NASDAQ) with a single trade.
ETFs thereby provide the flexibility to get into or out of a position at any time throughout the day, unlike mutual funds, which trade only once per day.
While the intraday trading capability is certainly a boon to active traders, it is simply a convenience for investors who prefer to buy and hold, which is still a valid and popular strategy – especially if we keep in mind that most actively managed funds fail to beat their benchmarks or passive counterparts, particularly over longer time horizons.
ETFs offer a convenient and low-cost way to implement indexing or passive management.
Active ETF Trading
In spite of indexing’s track record, many investors aren’t satisfied to settle for so-called average returns. Even though they know that a minority of actively managed funds beat the market, they’re willing to try anyhow. ETFs provide the perfect tool.
By letting intraday trading, ETFs give these traders an opportunity to track the direction of the market and trade accordingly.
Even though still trading an index like a passive investor, these active traders can benefit from short-term movements. If the S&P 500 races upward when the market opens, active trader can fetch in the profits immediately.
Therefore, all of the active trading strategies that can be used with traditional stocks can also be used with ETFs, such as marketing timing, sector rotation, short selling, and buying on margin.
Actively Managed ETFs
While ETFs are created to track an index, they could just as easily be designed to track a specific investment objective. Aside from how they are traded, such ETFs can offer investors and traders with an investment that aims to deliver above-average returns.
Actively managed ETFs have the potential to benefit mutual fund investors and fund managers as well. If an ETF is designed to mirror a particular mutual fund, the intraday trading capability will push frequent traders to use the ETF rather than the fund, which will decrease cash flow in and out of the mutual fund, making the portfolio easier to manage and more cost effective, enhancing the mutual fund’s value for its investors.
Transparency and Arbitrage
Active managed ETFs are widely available since there is technical challenge in creating them. The biggest issues confronting money managers all involve a trading complication, more specifically a complication in the role of arbitrage for ETFs.
Because ETFs trade on a stock exchange, there is the potential for price disparities to develop between the trading prices of the underlying securities. This creates the chance for arbitrage.
If an ETF is trading at a value lower than the value of the underlying shares, investors can profit from that discount by buying shares of the ETF and then cashing them in for in-kind distributions of shares of the underlying stock.