Exchange Traded Fund

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Overview

Overview

Instant diversification and exposure to a portfolio of securities in a single trade

Regular portfolio rebalancing aligns the fund with its underlying index and enables cost-efficient trading

Daily book value price transparency

Portfolio management done by capital market professionals

Definition

An Exchange Traded Fund or ETF is an open-end investment company that trades its shares in the stock exchange. An ETF company issues its shares in blocks called “Creation Units” in exchange for a basket of securities comprising the index it wishes to track. Creation is normally done by institutional investors, who break down the block into smaller portions and sell to retail investors in the Exchange.

ETFs have become one of the fastest growing investments in the world because they are simple to understand and provide opportunities for investors to create a diversified portfolio of stock with lower investment costs. Various funds have also set up ETFs because they are simpler to administer and have lower expense requirements compared to mutual funds or unit investment trust funds.

ETFs have what is called an underlying index, which it benchmarks against. Index is an indicator to measure or monitor the performance of a group of securities. For the PSE, its main index is the PSEi, which is composed of 30 of the largest and most liquid stocks.

In the case of the PSEi as seen in the graph, if ETFs were available at the start of 2009, the likely 4-year return of the ETF investment would have been 194.4% for a compounded annual growth rate of 31.0%.

There are 3 prices to look out for in ETFs: net asset value per share (NAVPS), iNAV and the trading price. NAVPS is the price per share of an ETF based on its book value, which is calculated every end of business day. This can be seen, along with the NAV and tracking error of the ETF, in the daily disclosure report of the company. iNAV is a more realtime calculation of the price per share of the ETF stock based on book value. The iNAV calculation is being refreshed by the minute based on the latest trading prices of the stocks included in its portfolio. Lastly, an ETF’s trading price is based on the prices of the bid, ask and done trades in the secondary market.

Benefits of Investing in ETF

Investors can diversify their investments in stocks with minimal capital outlay, allowing smaller retail investors to have access to blue chip companies. Diversification is an investment strategy that allows attainment of long-term goals while minimizing risk.
Investors, especially those who do not have enough time to monitor the stock market, can enjoy the returns of the overall market without having to actively manage their portfolio.
Since ETFs are traded in the Exchange, investors can immediately find out the ETF price (i.e. real-time) without having to wait for end-of-day, as observed in other investment funds.
Unlike other investment funds, ETFs have no sales-load commissions.
Some investment funds require a holding period and impose a surcharge on pre-termination. ETFs do not have this restriction, as it may be purchased and sold anytime during trading hours.
Investors know the composition of securities the ETF company has (i.e. the index components) because they are required to disclose this information. Other investment funds may opt to actively manage the fund and change the composition of its investment in securities without the prior knowledge of the investor.
ETFs present new opportunities for participants to earn returns through arbitrage, making this product attractive to institutional investors.
Investors can return the ETF shares in quantities of the Creation Unit in exchange for the underlying shares (i.e. the basket of securities).

Dimension	ETF	Mutual Funds	UITF
Intraday Trading	Yes	No	No
Publication of NAV / iNAV (*)	iNAV every minute and NAV at end-of-day	NAV at end-of-day	NAV at end-of-day
Management	Generally Passive	Usually Active	Can be both
Fees / Costs Involved fees	Similar to trading a stock – brokers commission, transaction fees, etc. *no sales load, no preterm fees	Front end load, back end load, redemption fee (if held less than the minimum time required)	Early redemption fee
Management Fees	Lower management fees	Higher management fees	Higher trustee fee
Redemption	Securities and/or Cash	Cash	Cash

(*) NAV – Net Asset Value

iNAV – indicative Net Asset Value

Trading ETF Shares

Just like ordinary stocks ETFs can be bought in the stock market through brokers. In addition, large retail or institutional Iinvestors that can supply the minimum number of underlying shares or basket of securities required to form a Creation Unit, can exchange such shares for ETF shares through a trading participant (brokers) authorized upon instruction by the ETF Company. This process is called “creation”. These investors will eventually break down the block of ETF shares into smaller portions and sell through the Exchange, Other all investors may now buy and sell through its trading participants (broker), just like any other stock.

Retail investors buy and sell ETF shares just as they would trades shares of any listed company.

Although the minimum investment to open a trading account with trading participants (brokers) vary from one to the next, the minimum investment to buy ETFs depends on the stock price at the time of trading and minimum lot size. For example, if the price of an ETF at the time of trading is between PHP 5 to PHP 49.95, then the minimum lot size is 100. As such, minimum investment is PHP 500 plus broker’s commission. On the other hand, if the price of an ETF at the time of trading is above PHP 50 but below PHP 1,000, then the minimum lot size is only 10. This time let’s say the price is at PHP 90, then the minimum investment is PHP 900 plus broker’s commission.

iNav Information

The Indicative Net Asset Value, or iNAV, is an indication of the current net value of the ETF shares” underlying securities and given on a per share basis. The iNAV is provided on a per minute basis during trading hours so as to timely guide investors on the movements of the ETF price vis-à-vis its underlying securities.

These two figures, the ETF share market price and the iNAV, give investors opportunities to arbitrage. Arbitrage is the almost simultaneous purchase and sale of similar or identical assets in order to profit from a difference in prices.

An ETF”s Net Asset Value (NAV) is calculated and available at the end of trading day and gives a view on the size and performance of the fund. Creation and redemption of ETF shares are based on NAV.

Tracking Error

Tracking error is a measure of how well the ETF is able to track the index. A lower value indicates better performance of the fund. The tracking error is the standard deviation of the difference in relative returns between the ETF and its underlying index. A number of factors may cause the tracking error to increase, such as: the composition of the underlying assets, the fund”s cash component, dividends and expenses such as management fees. ETFs have to disclose the maximum level of tracking error in its prospectus.

Creation and Redemption Process

ETF processes involving creation and redemption of shares can occur any time during trading hours. In the creation, the trading participant authorized by the ETF Company, called the Authorized Participant, surrenders the underlying shares to ETF Company and in return, the ETF Company gives equivalent ETF shares in Creation Units to Authorized Participant. In general, Creation is undertaken when the relative value of the underlying shares (as evidenced by the iNAV) is cheaper than the ETF shares. Thus, participants can buy relatively lower priced underlying shares and exchange them for ETF shares which may be trading at a premium.

Steps in Creation:

Step 1

Request for creation: Cross transaction done through PSE, where Authorized Participant surrenders underlying shares to the ETF Company in exchange for ETF shares.

Step 2

The Authorized Participant surrenders underlying shares to the Custodian.

Step 3

The Custodian confirms the availability of underlying shares.

Step 4

ETF Company instructs the Transfer Agent that ETF shares can be issued.

Step 5

Transfer Agent performs book entry movement of new ETF shares to be issued to the Authorized Participant.

Redemption is simply the reverse. The Authorized Participant surrenders ETF shares to the ETF Company in exchange for the corresponding underlying shares. This is undertaken when the ETF shares price is relatively cheaper than the value of the underlying shares.

Key Parties to an ETF

ETF Company
Fund Manager
Authorized Participant
Custodian
Transfer Agent

FAQs

List of ETFs

Downloads

Checklist

Title	Content
ETF Market Maker Renewal Application/Renewal Checklist
ETF Listing Checklist

References

Title	Content
ETF Brochure

Rules and Regulations

For ETF Rules and Regulations, CLICK HERE.

Market Makers

TP Name
First Metro Securities Brokerage Corp.