By Michael O'Neil Meditz, Associate Editor

Exchange-traded funds (ETFs) are increasing in popularity, as they are often responsible for approximately 50% of the daily trade volume on the American Stock Exchange (AMEX). ETFs are passive funds that track their related index and have the flexibility of trading like a security. They are managed by professionals and provide the investor with diversification, cost and tax efficiency, liquidity, marginability, are useful for hedging, have the ability to go long and short, and some even provide quarterly dividends.

ETFs are unit investment trusts (UITs) that have two markets. The primary market is where institutions swap "creation units" in block-multiples of 50,000 shares for in-kind securities and cash in the form of dividends. The secondary market is where individual investors can trade as little as a single share during trading hours on the exchange. This is different from open-end mutual funds that are traded after hours once the net asset value (NAV) is calculated.

The most widely traded and well-known ETF is the SPDR (pronounced spider, Standard and Poor's Depository Receipt). Other ETFs include Diamonds (Dow Jones Industrial Average), Qubes (Nasdaq-100 Index Tracking Stock) named after the ticker, QQQ, and Webs (World Equity Benchmark Shares). Webs mirror indices in foreign equity markets. There are currently 30 ETFs available on the AMEX and they include 17 Webs, 11 SPDRs (includes sectors), and one Qube and one Diamond.

Tax Advantages

Like open-end index funds, ETFs do not engage in active management and experience very low portfolio turnover. Also, ETFs provide additional tax benefits that mutual funds cannot offer. Mutual funds sell securities to cover redemptions that produce capital gains. ETFs transfer out, not sell, securities "in-kind" in the primary market. The institution can determine which, and how much of a security they are going to swap as long as it is of equal value to the amount being redeemed. The benefit of swapping securities at the lowest cost-basis is that it avoids capital gains. However, individual investors trading in the secondary market could be subject to capital gains since they do not have the opportunity to swap securities in kind.

                                         Next >>

Printer Friendly Page

E-Mail to a Friend