In our previous trading guides we discussed indices and how they work. In this guide, we’ll talk about a type of security that is similar to indices – an exchange-traded fund.

Compared to stocks that have been available to traders for centuries, and indices capturing traders’ attention for over the last few decades, ETFs are a relatively new product on the market. The first ETF was created only in 1990 in Canada and was quickly picked up by other countries. Due to the numerous advantages of these funds, the capital invested in ETFs reached USD 1 trillion by 2009 – less than ten years since its creation – and this number has been growing since.

In this article, we’ll explain what ETFs are, who creates them and how they compare to other financial instruments.

What are ETFs?

An exchange-traded fund (ETF) typically holds a collection of stocks or bonds, however they can also contain other financial instruments, such as commodities and cryptocurrencies. To a certain extent, ETFs are very similar to indices. However, there are also notable differences between these two instruments:

Analysts segregate ETFs into several categories depending on the types of instruments they are comprised of.

Types of ETFs

The most common way of categorising exchange-traded funds is by market, where each ETF tracks the performance of a particular set of underlying assets:

Index ETFs

Existing stock market indices, such as S&P 500.

Stock ETFs

Unique baskets of stocks grouped by industry, sector or location.

Commodities ETFs

Commodities, such as gold or oil.

Currency ETFs

Forex pairs individually or in groups.

Cryptocurrency ETFs

Individual cryptocurrency or a basket of digital currencies.

Bond ETFs

Stock market securities that governments, companies and other entities issue to raise capital. Bonds represent units of debt and an obligation to pay the full amount back, along with interest to the investors who buy them.

Besides markets, ETFs can also be divided into active and passive, depending on how they are managed. Active ETFs are managed by portfolio managers who hand-pick securities included in them.
On the other hand, the funds that track a stock market index, such as an index ETF, are usually considered passive as they don’t need active management.

Actively managed funds usually have a higher expense ratio than passive ones, which means investors need to pay higher fees when buying ETFs. However, for active traders, there is no difference.

It's worth mentioning that ETFs are quite often compared to index funds and mutual funds. All three types of securities are very similar in their structure, but there is a difference. An index fund is a passively managed basket of stocks identical to stock market indices used for investment purposes. A mutual fund is an actively managed basket of various stock market securities. The main difference between the three is that ETFs can be actively bought, sold and traded on a stock exchange during market hours just like regular shares, while investment in index and mutual funds can only be made once a day after at the end of the market session.

Let’s see how ETFs work to give you a clearer idea of these instruments.

Who creates ETFs?

The entity behind an ETF creation is called an ETF issuer. It is usually an authorised market participant, such as large company. To create an ETF, they purchase all the instruments that are going to be included in it and issue ETF shares. This means that when you invest in an ETF, you technically buy shares of a bundle of shares.

A person purchasing ETF shares has a legal claim to the shares included in it and is entitled to receive dividends on stocks paying them.

In some cases, an ETF issuer may involve another authorised market participant who will act as a sponsor responsible for purchasing the instruments within the ETF but will not manage it.

It is important to note that while any person with sufficient funds is eligible for ETF creation, it is subject to approval from the US Securities and Exchange Commission or another entity with similar functionality, depending on the location.

Top 5 biggest ETF issuers

The current market offers a vast selection of companies providing various ETFs to traders and investors. However, just like in any other industry, there are giants dominating the market. Since the two largest stock market exchanges are located in the US, the top five ETF providers are also based in the US, managing the majority of ETFs. However, each of these companies has a wide net of international offices taking care of the ETFs outside the US.

BlackRock Financial Management

BlackRock is the world’s largest asset manager, offering hundreds of ETFs under the ticker iShares, such as iShares MSCI Emerging markets (EEM).

The Vanguard Group

Vanguard is the world’s second-largest ETF provider, managing a little under a hundred exchange-traded funds under the Vanguard ticker, such as Vanguard SP 500 (VOO) and Vanguard Australian Shares High Yield (VHY).

State Street Global Advisors

With over a hundred exchange-traded funds in its portfolio, State Street investment management company offers them under the SPDR ticker, such as SPRD gold trust (GLD).

Invesco LTD

The Invesco investment management company offers a wide range of services, along with hundreds of ETFs listed under the Invesco ticker, such as Invesco DB Commodity Index Tracking Fund (DBC).

ProFunds Group

Mutual funds provider and the owner of ProShares Advisors LLC, ProFunds group offers a few dozen exchange-traded funds under the ProShares ticker, such as ProShares Bitcoin Strategy ETF (BITO).

ETF tickers

Like any other financial instrument, each exchange-traded fund has a unique ticker symbol for easier tracking and identification. However, since ETFs are complex baskets of securities, their ticker symbols look a little different.

The full name usually indicates the issuer and the underlying instrument, while the ticker symbol is used for tracking purposes. For example, SPDR gold trust is the full name of the ETF issued by State Street Global Advisors, tracking the price of gold. Its ticker symbol that you can see on our trading platforms is GLD.

Some ETFs may also reflect the location of their issuance. For example, ETFs issued in Europe often have the UCITS abbreviation in their name. Keep in mind that an ETF’s origin may play a significant role in an investment portfolio due to associated taxes, but it does not matter for derivative trading.

Let’s review the difference between ETF investing and ETF trading in our next article, How to trade ETFs.

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