• Home
  • Knowledge base
  • Useful Forms
  • FAQ

ETFs

  • Are ETFs considered derivatives?
    Most exchange-traded funds (ETFs) are not considered to be derivatives. In the aftermath of the 2008 financial crisis, many pundits pointed the finger of blame at derivatives and financial engineering as the primary causes of the market collapse. As a result, many investors have shied away from derivative-based securities and other new financial products to avoid the risks associated with them. Unfortunately, this risk aversion led to numerous misconceptions, especially about ETFs that had recently gained popularity.

    ETFs Are Not Derivatives, Unless They Are

    A derivative is a special type of financial security; its value is based upon that of another asset. For example, stock options are a derivative security, and their value is based on the share price of a publicly traded company such as General Electric. These options provide their owners with the right, but not the obligation, to purchase or sell GE shares at a specific price by a specific date. The values of these options, therefore, are derived from the prevailing GE share price, but they do not involve an actual purchase of those shares.

    Equity-based ETFs are similar to mutual funds in that they own shares outright for the benefit of fund shareholders. An investor who purchases shares of an ETF is purchasing a security that is backed by the actual assets specified by the fund’s charter, not by contracts based on those assets. This distinction ensures that ETFs neither act like nor are classified as derivatives.

    While ETFs are generally not considered derivatives, there are exceptions. Recent history has seen the rise of numerous leveraged ETFs that seek to provide returns that are a multiple of the underlying index. For example, the ProShares Ultra S&P 500 ETF seeks to provide investors with returns that equal twice the performance of the S&P 500 index. If the S&P 500 index rose 1% during a trading day, shares of the ProShares Ultra S&P 500 ETF would be expected to climb 2%. This type of ETF should be considered a derivative because the assets in its portfolio are themselves derivative securities.


  • Are there leveraged ETFs that track the banking sector?
    A:

    A number of exchange-traded funds (ETFs) track the banking sector. Among them are ProShares Ultra KBW Regional Banking, ProShares UltraPro Short Financials, ProShares UltraPro Financials, Direxion Daily Financial Bull 3X Shares and Direxion Daily Financial Bear 3X Shares.

    ProShares is a leading company offering leveraged ETFs that track a variety of sectors. Alternative ETFs, such as those offered by ProShares, provide investors with the opportunity to decrease risk and volatility, and the opportunity to maintain a speculative position without the obligation of purchasing derivatives.

    ProShares Ultra KBW Regional Banking (KRU)

    This fund seeks results that track two times that of the daily performance of the KBW Regional Banking index. The KRU fund invests in both derivatives and securities that ProShare advisors believe will provide investors with twice the daily returns of the index. The index, which is non-diversified, comprises 50 stocks of companies that conduct business as regional banks or thrifts. Some of this fund’s top holdings as of 2015 include First Niagara Financial Group, Investors BanCorp and SVB Financial Group.

    ProShares UltraPro Short Financials (FINZ)

    This fund aims to achieve three times the opposite, or inverse, of the daily performance of the Dow Jones U.S. FinancialsSM Index. This non-diversified fund makes investments in derivatives that, in combination, provide investors with a return based on declines in the value of the Dow financial index, which measures the overall financial services sector performance in the U.S. equity market.

    ProShares UltraPro Financials (FINU)

    The investment seeks daily investment results, before fees and expenses, that correspond to three times (3X) the daily performance of the Dow Jones U.S. FinancialsSM Index. The fund invests in securities and derivatives designed to have similar daily returns to three times (3X) the daily return of the index. This fund is non-diversified, and its primary holdings as of 2015 include Berkshire Hathaway and Wells Fargo.

    ProShares Ultra Financials (UYG)

    This leveraged ETF provides daily investment results that correspond to two times (2X) the daily performance of the Dow Jones U.S. FinancialsSM Index. The fund invests in securities and derivatives chosen to mirror this primary index for tracking the financial sector. While the financial sector includes industries besides the banking industry, banks are a major component of the sector and, thus, the index as well. Primary holdings of this ETF as of 2015 include JPMorgan Chase and Wells Fargo.

    Direxion Daily Financial Bull 3X Shares (FAS)

    The Direxion Financial Bull 3X fund is designed to have daily investment results equal to 300% of the performance of the Russell 1000 Financial Services Index. The fund creates long positions by investing at least 80% of its assets in the securities that make up the Russell 1000 Financial Services Index or in financial instruments that provide leveraged or unleveraged exposure to the index. These financial instruments include futures contracts, options on securities, indexes, swap agreements and contracts for differences (CFDs).

    Direxion Daily Financial Bear 3X Shares (FAZ)

    This ETF aims for daily investment results that approximate 300% of decreases in the performance of the Russell 1000 Financial Services Index. This fund creates short positions by investing at least 80% of its assets in futures contracts, options on securities, swap agreements and other financial instruments that, in combination, provide inverse leveraged exposure to the Russell 1000 Financial Services Index.


  • Are Vanguard ETFs commission-free?
    A:

    While some Vanguard exchange-traded funds (ETFs) are available commission-free from third-party brokers, a large portion still bear commissions. Whether a particular ETF is commission-free depends on the investment broker platform. However, buying Vanguard ETFs through the Vanguard investment platform comes free of any trading charges.

    Vanguard ETFs

    Vanguard offers a competitive selection of ETFs with different categories and investment focuses suitable for investors interested in gaining exposure to equity and bond markets in the United States and overseas. While about half of over 60 Vanguard ETFs specialize in domestic equities, there is a significant portion of funds that invest in international equities and corporate and sovereign bonds. Vanguard ETFs have very competitive expense ratios among their peers due to superior investment selection and execution. As of Dec. 31, 2014, the average expense ratio for Vanguard ETFs is about 0.13%, which is substantially lower than the average expense ratio of 0.55% for the ETF industry.

    Commissions for Vanguard ETFs

    Check with an investment broker to determine whether buying a particular Vanguard ETF entails any trading commissions. Almost all investment brokers have a screener for ETFs that allows investors to quickly filter ETFs by fund family and transaction-free status. If a Vanguard fund has a no-transaction fee status, investment brokers do not charge investors any commissions to buy or sell shares of this ETF. Otherwise, standard trading fees for funds apply based on a particular broker's fee policy.

    Investors who conduct their investment business through Vanguard can purchase any Vanguard ETF free of commissions. Vanguard offers competitive trading commissions for all other ETFs available through its investment platform.


  • book value per common share & NAV (net asset value)
    A:

    Book value per common share, also known as book value per equity of share or BVPS, is used to evaluate the stock price of an individual company, whereas net asset value, or NAV, is used as a measure for evaluating all of the equity holdings in a mutual fund or ETF.

    Book value per common share is an evaluation measure investors and analysts use to assess a conservative value of a company’s common stock equity. The value generated from the formula for this per share evaluation shows the original value of the company’s stock, adjusted for outflows of dividends and stock buybacks and inflows of earnings modifiers, compared to total current outstanding shares. Book value per common share is calculated as follows:

    BVPS = value of common equity / number of shares outstanding
    (preferred stock is not included in the calculation)

    BVPS can be an important metric that helps investors determine if a stock is undervalued. However, BVPS gives only a narrow picture of the company’s overall current situation without factoring in future prospects, and therefore is an insufficient single indicator of a stock's potential future value.

    Net asset value, or NAV, is a per share value calculated for a mutual fund or an exchange-traded fund, or ETF. For any of these investments, the NAV is calculated by dividing the total value of all the fund's securities by the total number of outstanding fund shares. NAV is generated daily for mutual funds. Total annual return is considered by a number of analysts to be a better, more accurate gauge of a mutual fund's performance, but the NAV is still used as a handy interim evaluation tool. Because ETFs are traded in the same way as stocks, their share prices can trade at a premium, or above the NAV, or at a discount, or below, the net asset value. NAV calculations are also used to evaluate real estate investment trusts, or REITs, although precise value of REIT holdings can be difficult to determine.


  • Do ETFs pay capital gains?
    A:

    Exchange-traded funds (ETFs) can generate capital gains that are transferred to shareholders, typically once a year, triggering a taxable event. Although very rare, ETFs have capital gains from time to time due to one-time large transactions or unforeseen circumstances. Because ETFs are structured as registered investment companies, they act as pass-through conduits, and shareholders are responsible for paying capital gains taxes.

    Exchange-Traded Funds

    ETFs invest in individual securities, such as stocks, bonds and derivatives with specific investment objectives. Typically, ETFs are passively managed, where they follow a certain equity or bond index and only rebalance their portfolios when significant changes occur to the underlying benchmark. Shares of ETFs are traded like stocks on major U.S. stock exchanges, such as the NASDAQ and the New York Stock Exchange.

    ETFs became very popular among investors due to their transparent and simple investment strategies and low expense ratios. As of December 2014, there were 1,411 ETFs registered in the United States with total net assets of approximately $2 trillion, representing 13% of total net assets under management of mutual funds, ETFs and other trusts and closed-end funds.

    Capital Gains of ETFs

    Holding ETFs in a taxable account typically generates less capital gains when compared to mutual funds, because ETFs do not necessarily have to sell the underlying securities to finance investment inflows and outflows. Through authorized participants, ETFs can create or redeem "creation units," which are blocks of assets that represent an ETF's securities exposure on a smaller scale. By doing so, ETFs typically do not expose their shareholders to capital gains.

    Occasionally, an ETF may incur a capital gain due to some special circumstances, where it has to drastically rebalance its portfolio due to substantial changes in the underlying benchmark. Also, leveraged, inverse and emerging market ETFs typically cannot use in-kind delivery of securities to create or redeem shares. This triggers capital gains more often for these kinds of ETFs when compared to index ETFs.


  • Do speculators have a destabilizing effect on the financial system?
    A:

    A speculator is anyone who trades derivatives, commodities, bonds, equities or currencies with higher-than-average risk in return for higher-than-average profit potential. Speculators can include individual investors, institutional investors, hedge funds, pension funds, investment banks, index funds and exchange-traded funds (ETFs), and can participate in any financial market. The key role of speculators in the market place is to add liquidity by providing buyers and sellers with partners for their desired trades. Liquidity maintains order within the financial markets and is the key driver behind efficient exchanges. Speculators add huge amounts of money to the markets, and the more money they invest in the market, the more liquid it becomes. An efficient market (very liquid) allows for buyers and sellers to trade with one another with relative ease without causing large shifts in prices.

    Speculators in the past have come under much scrutiny for the unpredictability of the markets, namely the sharp peaks and valleys associated with prices in the commodity markets. While speculators have been labeled as greedy and irresponsible during times of high gas and food prices or sudden currency devaluations, it is important to mention that speculators are not solely to blame for these sharp increases or decreases in value.

    Financial systems are guided by countless micro and macroeconomic factors, along with the movement of financial markets. Increased demand for commodities, equities and currencies will almost certainly drive the value of these items upward, and with increased demand comes more buyers. Without a comparable amount of sellers in the marketplace it becomes illiquid, creating an inefficient marketplace which could lead to even higher prices. Speculators, by taking on the increased risk of adding large sums of money to the market place to create liquidity, demand increased profits for those risks. It has been argued that speculators actually have a calming effect on the market place due to their large positions and constant need to balance those positions. As well, speculators allow countless individuals and institutions to protect their investments by providing a willing trading partner in hedging strategies. (For more on commodities, read An Overview Of Commodities Trading.)

    Although speculators are an integral part of the financial landscape, it should be noted that there have been many cases of speculators manipulating the markets illegally to profit from the results. Such speculation can be difficult to monitor and can drastically affect the financial system. Speculators are a very important component to the marketplace, but speculators who partake in "excessive speculation" can definitely have a destabilizing effect on the financial system.

    To learn about speculating read our related article Arbitrage Squeezes Profit From Market Inefficiency.


  • Do Vanguard ETFs pay dividends?
    Most Vanguard exchange-traded funds (ETFs) pay dividends on a regular basis, typically once a quarter or year. Vanguard ETFs specialize in one specific area within stocks or the fixed-income realm. Vanguard fund investments in stocks or bonds typically pay dividends or interest, which Vanguard distributes back to its shareholders in the form of dividends to meet its investment company tax status.

    Vanguard ETFs

    Vanguard offers investors over 60 different ETFs that specialize in specific sector stocks, stocks of a certain market capitalization, foreign stocks, and government and corporate bonds of different durations and risk. The majority of Vanguard ETFs are rated four stars by Morningstar, Inc., with some funds having five or three stars. One unique feature of Vanguard funds, in general, is they are known in the fund industry for their low expense ratios. As of October 2015, Vanguard ETFs' net expense ratio ranges between 0.05 and 0.34%, while the average expense ratio is about 0.13% for a typical Vanguard ETF. The most expensive funds tend to be those that invest overseas or have high turnover ratios and specialize in very narrow market niches.

    Vanguard ETFs' Dividend Yields

    ETFs are typically judged on their dividend distributions based on a 30-day SEC yield, which is a standardized yield developed by the Securities and Exchange Commission (SEC) for the fair comparison of funds. The 30-day SEC yield is calculated based on the last 30-day period and reflects investment income earned by a fund after deducting its expenses.

    As of October 2015, over 50 Vanguard ETFs pay dividends in the form of quarterly or annual distributions. While it is uncommon, there are a few Vanguard funds that pay dividends monthly. The 30-day SEC yield for Vanguard ETFs ranges between 0.46 and 5.11%. Equity Vanguard ETFs typically have 2% yields, while bond ETFs have a wide range of yields depending on the portfolio duration and risk.


  • Do Vanguard ETFs require a minimum investment?
    Vanguard completely waives any U.S. dollar minimum amounts to buy its exchange-traded funds (ETFs), and the minimum ETF investment is one share. Vanguard offers various ETFs with a wide spectrum of investment objectives at very low expense ratios.

    Advantages of Vanguard ETFs

    Vanguard has a highly competitive selection of ETFs available for purchase at numerous investment brokers' platforms with some ETFs being commission-free. Vanguard ETFs typically use a passive investment approach and follow a particular stock or bond index. Because of superior investment sampling methodology, Vanguard ETFs are known for their low turnover ratios, low tracking errors and low expense ratios. Based on available data as of Dec. 31, 2014, the Vanguard average ETF expense ratio was 0.13%, which is significantly below the ETF industry's average expense ratio of 0.55%.

    Unlike mutual funds, Vanguard ETFs do not have any minimum investment requirements because their shares are traded and treated as any other stock. Investors can purchase a minimum of one share of any Vanguard ETF through their investment brokers.

    Different Types of Vanguard ETFs

    Vanguard offers different categories of ETFs that broadly specialize in investing in fixed-income securities or stocks. The majority of Vanguard ETFs invest in domestic stocks on U.S. equity markets, while the second-largest category of Vanguard ETFs is taxable bonds. There are also a few ETFs in the international stocks and specialty categories. The specialty category includes ETFs that track the performance of an industry or sector-specific index, such as energy, financials, health care and information technology.


  • How are ETF fees deducted?
    A:

    Investment management fees for exchange-traded funds (ETFs) and mutual funds are deducted by the ETF or fund company, and adjustments are made to the net asset value (NAV) of the fund on a daily basis. These management fees are never directly seen on any investor statements and are handled in-house by the fund company.

    ETF Fees

    Each day, an ETF company experiences expenses such as salaries, utility expenses and research expenses. The net gross assets of a fund are adjusted downward by these daily expenses to arrive at the NAV. Some smoothing within the accounting departments of the fund may take place to even out these expenses over time, but the overall stated investment management fee is taken away from the NAV as evenly as possible.

    Assume an ETF has a stated annual expense ratio of 0.75%. On an investment of $50,000, the expected expense to be paid over the course of the year is $375. If the ETF returned precisely 0% for the year, the investor would slowly see his $50,000 move to a value of $49,625 over the course of the year. The net return the investor receives from the ETF is based on the total return the fund actually earned minus the stated expense ratio. For example, if the ETF perfectly tracks the Standard and Poor's 500 Index and the index itself returned 15% last year, the investor would see his ETF increase in value by 14.25%. This is the total return minus the stated expense ratio.


  • How do leveraged ETFs compound volatility? (SPXL)
    A:

    Leveraged ETFs often advertise their volatility versus a tracked index with the multiple included in the name of the fund. For example, an investor who buys the Direxion S&P 500 Bull 3x ETF (NYSEARCA: SPXL) assumes that the fund triples the volatility of that index. What is not mentioned in the title is a second element that is part of all leveraged funds, referred to as “rebalancing,” that can compound volatility whether the underlying index is increasing or decreasing.

    The Structure of Leveraged ETFs

    Leveraged ETF structures vary between funds and their objectives. For example, a fund that provides 3x long exposure might be composed of an equity position combined with cash, long futures and other derivatives, such as swaps. Inverse funds, which are structured to deliver leveraged returns on declining prices, are likely composed of short futures contracts, cash and swaps. When these elements are rebalanced, the result can be either positive or negative compounding.

    How Positive Compounding Works

    Leveraged ETFs are rebalanced after the market close each day to bring them in line with their stated objective for the following trading day. For example, if an investor buys 1,000 shares of a 3x ETF at $10 per share, the leverage increases the exposure to the underlying index to $30,000, or three times the $10,000 cost of the shares.

    If the index closed the next day with a gain of 5%, the shares gain 15%, or three times the 5% gain, increasing the ETF's share price to $11.50 per share. To bring the fund’s stated leverage in line with the day’s closing price, the share structure is rebalanced to increase exposure to the index to $34,500, or three times the 1,000 shares times the $11.50 share price. The resulting increased exposure creates the opportunity for positive compounding if the price of the index appreciates the following trading day.

    Negative Compounding at Work

    Rebalancing also takes place when the underlying index for a leveraged ETF declines. Downward rebalancing tends to exacerbate losses and can diminish a leveraged ETF’s performance, even when the direction of the index has a general correlation with the fund's objective.

    Using the $11.50 per share ETF described above, an index loss of 5% on the following day reduces the share price by $1.72 to bring the share price down to $9.78. In addition to generating a larger loss than the previous day’s gain, rebalancing the shares also reduces the exposure to the index to $29.34, or three times the $9.78 share price.

    Negative compounding would gain speed if the underlying index were to lose another 5% on the following day. This loss would drop the share price to $8.32 per share, for a cumulative loss of 16.8% versus a net loss on the index of 5.2%. Subtracting only the 5.2% loss at 3x leverage, the loss on the ETF is 15.6%, but the negative compounding due to rebalancing increases the loss by an additional 1.2% over only two days.

    The Takeaway

    The rebalancing involved in leveraged ETFs can result in either positive or negative compounding. For investors, the challenge is that the true power of positive compounding is only exhibited on uninterrupted moves that correlate with fund objectives. When markets move erratically, the negative compounding that occurs on days when downward rebalancing takes place can diminish overall performance.

    However, the biggest threat for investors comes when positions held as an index make a sustained move against a leveraged ETF. In those situations, negative compounding can magnify accelerating losses resulting from the leverage built into the fund.


  • How do you calculate the excess return of an ETF or indexed mutual fund?
    A:

    For exchange-traded funds (ETFs), the excess return should be equal to the risk-adjusted (or beta) measure that exceeds the instrument's benchmark or annual expense ratio. It's easy to assess index mutual funds against the benchmark index: just subtract the benchmark's total return from the fund's net asset value to find excess return. Due to mutual fund expenses, the excess return for an index fund is typically negative.

    As a general rule, investors prefer index mutual funds and ETFs that outperform their benchmarks and have positive excess returns. Some investors and analysts believe that it is almost impossible to generate excess returns over an extended time period for managed mutual funds due to the prevalence of high fees and market uncertainty.

    Calculating Excess Return for Exchange Traded Funds

    Similar to most index mutual funds, most ETFs underperform relative to their benchmark indexes. ETFs tend to have higher excess returns on average than index mutual funds.

    Think of the expected return for an ETF as the ETF's alpha for a given price and risk profile. Several different measures of risk can be used to pair up an ETF with a benchmark; one common example is to use the weighted average cost of equity. If you don't have or don't want to use the annual expense ratio or a simple benchmark when calculating an ETF's excess return, use total return in excess of the expected return based on the capital asset pricing model formula.

    The CAPM formula can be written as: total ETF return = (risk-free rate of return) + (ETF beta * (market return - risk-free rate of return)) + excess return.

    Rearranged, the formula looks like: excess return = (risk-free rate of return) + (ETF beta * (market return - risk-free rate of return)) - total ETF return.

    Using the CAPM method, you can compare two portfolios or ETFs with equal or highly similar risk profiles (beta) to see which produces the most excess returns.

    Calculating Excess Return for Index Funds

    Index funds are, by their nature, designed to avoid large positive or negative excess returns relative to their index. Index fund creators use risk-control techniques and passive management to minimize expected deviation from the benchmark.

    Calculating the excess returns for an index fund is easy. To take a simple case, compare an S&P 500 index mutual fund's total returns to the S&P 500 performance. It is possible, though unlikely, for the indexed fund to outperform the S&P 500. In this case, the expected returns will be positive. It is more likely that the small level of administrative fees produce a slightly negative expected return.


  • Is it possible to invest in an index?
    A:

    First, let's review the definition of an index. An index is essentially an imaginary portfolio of securities representing a particular market or a portion of it. When most people talk about how well the market is doing, they are actually referring to an index. In the United States, some popular indexes are the Standard & Poor's 500 Index (S&P 500), the Nasdaq and the Dow Jones Industrial Average (DJIA). (Read more about the different indexes here: A Market by Any Other Name.)

    While you cannot actually buy indexes (which are just benchmarks), there are three ways for you to mirror their performance:

    1. Indexing: You can create a portfolio of securities that best represents an index, such as the S&P 500. The stocks and the weightings of your allocations would be the same as in the actual index. Adjustments would have to be made periodically to reflect changes in the index. This method can be quite costly, since it requires an investor create a large portfolio and make hundreds of transactions a year.

    2. Buy index funds: Index funds are a cheap way to mimic the marketplace. While index funds do charge management fees, they are usually lower than those charged by the typical mutual fund. There are a variety of index fund companies and types to choose from, including international index funds and bond index funds. To learn more about the variety of indexes and the calculations involved, check out our Index Investing tutorial. 

    3. Index ETFs: Exchange-traded funds track an index and, like index funds, represent a basket of stocks but, like a stock, trade on an exchange. You can buy and sell ETFs just as you would trade any other security. The price of an ETF reflects its net asset value (NAV), which takes into account all the underlying securities in the fund.

    Because index funds and ETFs are designed to mimic the marketplace or a sector of the economy, they require very little management. The beauty of these financial instruments is that they offer the diversification of a mutual fund at a much lower cost.


  • Should I invest in ETFs or index funds?
    A:

    Exchange-traded funds, or ETFs, and index funds are very popular with investors; both offer advantages over actively managed mutual funds. The question of whether to include them in your investment portfolio is largely decided by whether they suit your personal investment style, strategy and goals.

    Index funds are passively managed mutual funds designed to mirror the performance of a market index such as the S&P 500. The two primary advantages of passively managed index funds over actively managed mutual funds are (1) lower management expense ratios, which are typically one-half to two-thirds less than actively managed fund fees and (2) simply the fact that index funds have historically outperformed the majority of actively managed funds. However, there are some actively managed funds that generate significantly higher investment returns than index funds, and the primary disadvantage of index funds is the lack of flexibility that automatically precludes them from ever being able to make dramatic gains over and above average market performance.

    An ETF is an equity investment constructed to track a commodity, index, market sector or basket of assets, which is traded in the same way as an individual stock. ETFs have skyrocketed in popularity with investors since their appearance on the investment stage. The comparison of ETFs to mutual funds involves several factors, but the current consensus is that the overall advantage goes to ETFs. Among notable advantages, ETFs offer the following:

    - As they can be traded like stocks, ETFs offer the advantage of being more liquid. They can be bought or sold any time during trading hours. They are more flexible. They can be sold short; ETFs are even exempt from the uptick rule on short selling that applies to stocks. They can also be purchased on margin, bought with limit orders and hedged with options.
    - ETFs have lower management fees.
    - They are more favorable in regard to taxes; by buying and selling in "like-kind exchanges," ETFs avoid a taxable event, which avoids the daily redemption costs that funds incur and minimizes capital gains taxes.
    - ETFs are more accessible to small investors because investors can buy individual shares of an ETF, while many mutual funds have minimum investments of $2,500 or more. This can be a disadvantage in terms of transaction costs since buying ETFs means paying a brokerage commission.
    - ETFs provide easier access to alternative investments, creating a broader range of investment opportunities. There are ETFs that invest in commodities and foreign exchanges, and offer the ability to invest extensively in foreign and emerging markets.

    One disadvantage of ETFs is that they cannot reinvest dividends.

    Index funds are generally more suited to less sophisticated, more risk-averse investors who have longer-term investment horizons. For example, those who are using equity investing as part of a long-term retirement plan and prefer to keep things simple, minimize investment costs and look to make reasonable profits from the historical trend of market values to increase over time.

    ETFs are more appealing to investors with more hands-on investment styles, those aggressively seeking higher short-term returns on investments and sophisticated investors who desire greater access to alternative investments such as the forex market and futures.


  • The most common ETFs that track the metals and mining sector
    A:

    There are two general types of ETFs that track the metals and mining sector. There are ETFs that invest in mining companies and there are ETFs that invest directly in physical metals.

    The most common ETFs that track the metals and mining sector are:

    Precious Metals

    A fund that invests in a basket of several precious metals is the ETFS Physical PM Basket (NYSE:GLTR,) which aims to replicate the return of physical gold, silver, platinum and palladium.

    Gold

    The SPDR Gold Trust (GLD) invests in physical gold and hosts returns that have historically matched the precious metal closely. The Market Vectors Gold Miners ETF (GDX) invests in gold mining companies and uses the NYSE Arca Gold Miners Index as a benchmark.

    Also available and commonly traded are more exotic ETFs that offer returns leveraged to the price of physical gold or returns inverse to the price of gold. The ProShares Ultra Gold (UGL), which seeks to double the return of bullion and the ProShares UltraShort Gold (GLL), which seeks to provide double inverse bullion performance, are examples of types of these sophisticated ETFs.

    Silver

    The largest and most popular silver ETF is the iShares Silver Trust (SLV), which holds the objective of matching the return of physical silver. The Global X Silver Miners ETF (SIL) invests in silver mining companies and seeks to meet or exceed the returns of the Solactive Global Silver Miners Index.

    A short silver ETF option exists with the ProShares UltraShort Silver (ZS). This ETF seeks to double the inverse performance of the price of physical silver.

    Platinum

    An ETF that aims to match returns offered by investing in physical platinum is the ETFS Physical Platinum (PPLT). An ETF that invests in the shares of platinum mining companies is First Trust ISE Global Platinum ETF (PLTM,) which uses the ISE Global Platinum Index as a benchmark.

    Palladium

    A closely related trust, rather than a fund, with returns linked to investing in physical palladium is offered by the ETFS Physical Palladium trust (PALL). The trust seeks to match the performance of the price of physical palladium.

    Base Metals

    A popular base metals ETF with assets of over $220 million is the PowerShares DB Base Metals ETF (DBB). The fund tracks the performance of the Deutsche Bank Liquid Commodity Index - Optimum Yield Industrial Metals Excess Return.

    Copper

    Though it is technically a note and not a fund, the iPath DJ-UBS Copper SubTR ETN (JJC) aims to match the performance of an un-leveraged futures position in copper and is the largest and most actively traded copper ETF.

    There are two copper mining ETFs that are popular with investors: the Global X Copper Miners ETF (COPX), which seeks to replicate the performance of the Solactive Global Copper Miners Index and the First Trust ISE Global Copper ETF (CU), which tracks the ISE Global Copper Index.

    Nickel

    The most commonly traded pure Nickel ETF is the iPath DJ-UBS Nickel SubTR ETN (JJN). Technically, this is a note and not an ETF. The ETF seeks to track the performance of an un-leveraged position in nickel futures.

    Steel

    The $69 million Market Vectors Steel ETF (SLX) seeks to replicate the performance of the NYSE Arca Steel Index.


  • What are all of the securities markets in the U.S.A?
    A:

    The three major U.S. financial securities markets are:

    • New York Stock Exchange (NYSE): The NYSE is a stock exchange based in New York. In April 2007, the New York Stock Exchange merged with a European stock exchange known as Euronext to form what is currently NYSE Euronext. NYSE Euronext also owns NYSE Arca (formerly the Pacific Exchange).
    • National Association of Securities Dealers Automated Quotation System (Nasdaq): The Nasdaq is the largest electronic screen-based market. It currently offers lower listing fees than NYSE.
    • American Stock Exchange (AMEX): Unlike the Nasdaq and NYSE, AMEX focuses on exchange-traded funds (ETFs).

    Other exchanges in the United States include:

    • Boston Stock Exchange (BSE) - made up of the Boston Equities Exchange (BEX) and the Boston Options Exchange (BOX) and was acquired by Nasdaq in 2007
    • Chicago Board Options Exchange (CBOE)
    • Chicago Board of Trade (CBOT) - owned run by CME Group Inc.
    • Chicago Mercantile Exchange (CME) - owned and controlled by CME Group Inc.
    • Chicago Stock Exchange (CHX)
    • International Securities Exchange (ISE) - includes ISE Options Exchange and the ISE Stock Exchange
    • Miami Stock Exchange (MS4X)
    • National Stock Exchange (NSX)
    • Philadelphia Stock Exchange (PHLX)

     


  • What are Schedule K-1 documents used for?
    A:

    The Schedule K-1 is a tax document issued for an investment in partnership interests. The purpose of the Schedule K-1 is to report your share of the partnership's income, deductions and credits. It is issued around the same time as Form 1099 and serves a similar purpose for tax reporting.

    While a partnership is generally not subject to income tax, you are liable for tax on your share of the partnership income, whether or not it's distributed. This tax document is commonly issued by investors when they invest in limited partnerships (LPs) and some exchange-traded funds (ETFs), such as those that invest in commodities.

    The Schedule K-1 tends to have a reputation for being one of the last tax documents to be received by the taxpayer when gathering all of their tax documents to file the federal tax return. To add insult to the wait, the Schedule K-1 can be quite complex and require multiple entries on the taypayer's federal return, including such entries on the Schedule A, Schedule B, Schedule D and, in some cases, Form 6781.

    For more, read: 10 Steps to Tax Preparation.


  • What are some of the best small cap index funds?
    A:

    The best small-cap index funds are the iShares Russell 2000 ETF (IWM), SPDR S&P 600 Small Cap ETF (SLY), Vanguard Russell 2000 ETF (VTWO) and Vanguard Small Cap Index Fund (VB). These funds are rated highly by U.S. News & World Report in terms of liquidity, costs and diversification.

    The most tracked and traded small-cap exchange-traded fund, or ETF, is IWM. Many investors prefer watching small-cap funds to more mainstream indexes such as the S&P 500 or Dow Jones Industrial Average (DJIA), feeling they are a better representation of the economy and overall stock market. This is because small caps are more sensitive to economic growth and are domestically focused.

    Small caps are unique in that they are highly leveraged to the economy. These companies have smaller balance sheets and are more exposed to the economic cycle. During recessions, many may go bankrupt. This is in contrast to mid- and large-cap companies that have more established operations and reserves to get through and thrive during turbulent times.

    For these reasons, small caps are considered a leading indicator for the economy. When traders become enthused about prospects for economic growth, they move into small caps. When they are worried about a slowdown, they start to sell small caps first.

    Large-cap companies tend to do business all over the world. More than half of revenues of the S&P 500 come from abroad. In contrast, more than 90% of revenue for small caps comes domestically. Therefore, periods of relative outperformance of small caps to large caps is meaningful in implying domestic economic strength.


  • What are the differences between an MLP exchange traded fund (ETF) and an MLP exchange traded note (ETN)?
    A:

    The main difference between a master limited partnership (MLP), exchange-traded fund (ETF) and an MLP exchange-traded note (ETN) is the tax consequences for distributions from each asset. Both MLP ETFs and ETNs track an underlying MLP index. MLP ETFs are often structured as C corporations. These corporations pay corporate income tax on distributions before the distributions are passed through to investors. This reduces the performance of the ETF. One of the distinct advantages of MLPs is their pass-through taxation structure, where there are no taxes paid at the partnership level. This avoids the double-taxation issue. By paying corporate taxes for the ETF structure, one of the main benefits of MLPs is negated. This means the MLP has a significant tracking error versus the performance of the underlying MLPs.

    The MLP ETN is organized as unsecured debt issued by a bank, which tracks the MLP index. This avoids the payment of corporate taxes and leads to better tracking with the MLP index. The drawback to this structure is distributions are treated as taxable income, which has certain tax consequences.

    With an outright ownership interest in an MLP, distributions are not taxed as ordinary income at the time they are received. Rather, these distributions are considered reductions in the cost basis for the investment. Any taxes on distributions are deferred until the interest in the MLP is conveyed. Due to the significant depreciation and other tax deductions of MLPs, the distributable cash flow is often higher than the taxable income, creating efficient tax deferral. Most MLPs are in the energy sector due to certain restrictions Congress placed on the use of the MLP structure in 1987. These MLPs often have large capital investments in gas and oil pipelines and storage, which realize depreciation on a yearly basis.

    If the MLP interest is transferred to the heirs of the holder, the cost basis in the MLP units is adjusted to the value as of the transfer date. This eliminates any tax liability caused by the return of capital distributions made previously. This can be a strong estate planning tool if utilized correctly. Thus, these distinct ownership advantages are not realized if an MLP ETN or ETF is owned as opposed to units directly in the MLP.

    Both the ETF and the ETN allow investors to avoid having to file a K-1 tax filing, which is an advantage. A K-1 is required for distributions received from the outright ownership of an MLP, which can complicate tax filings for many investors. Unit holders are considered owners in the business since they are limited partners.

    In addition, the MLP ETFs and ETNs may be held in individual retirement accounts (IRAs) without negative tax consequences. If MLP units are held directly in an IRA, the IRS has defined distributions from the MLPs as unrelated business taxable income that must be paid in the year it is realized. This cancels out the tax-deferred advantages of MLP distributions. Thus, there may be advantages to the ETFs and ETNs for investors who want investments in MLPs in their IRAs.


  • What are the main benchmarks that track the banking sector?
    A:

    The appropriate benchmarks for tracking banking sector performance depend on the type of banking. For instance, commercial-only banks can be evaluated very differently than retail-only banks. For smaller savings and loans institutions, standard benchmarks include net interest margins, the ratio between equity and total assets, and accounts receivable collection ratios. Huge multinational firms should be tracked with profitability, average net asset values and market indexes designed to track the overall performance of one sector.

    Other benchmarks can be more specifically selected through exchange-traded funds (ETFs) or mutual funds. It's likely that ETFs can provide a better overall benchmark for a whole sector than mutual funds.

    Sector Benchmarking

    The term "benchmark" is thrown around a lot in financial literature, but it doesn't always mean the same thing in every possible situation. In corporate governance and business consulting, for instance, benchmarking is the process by which one company tracks the performance of and tries to emulate a leading competitor. Investors might establish benchmarks as goals within the context of a long-term financial strategy.

    Sector benchmarking is different. Investors and analysts look to sector benchmarks as a reference point. They can compare the performance of their portfolios or a specific stock against the generalized performance of an entire industry.

    In terms of banking sector benchmarking, this means tracking market indexes tied to the financial services sector. Industries such as banking, insurance and others are likely to be included.

    A banking sector index is designed to track the stock market performance of major banking companies. The Dow Jones has specific subindexes (such as the U.S. Financials Index) based on companies with large market capitalizations that are traded on the New York Stock Exchange.

    Other investors avoid weighted benchmarks and track the average fundamentals of publicly reporting companies within a specific sector.

    Fundamentals of Banking

    Banks are not all homogeneous, so each fundamental metric reflects better on some firms over others. Most banks are concerned with their net interest margins. Fundamental investors should also look at average capitalization ratios.

    A sector is likely to correlate more consistently with broad economic performance than individual firms do. Investors should also keep an eye on interest rate policy, Federal Reserve action and the value of high-priced assets,

    Equities as Benchmarks

    ETFs are meant to mirror or closely mirror the performance of indexes. Popular ETFs that track the banking sector include the Financial Select Sector SPDR, the SPDR S&P Bank ETF and the Nasdaq American Banking Association Community Bank Index Fund.

    The American banking sector could just as well be benchmarked with a mutual fund comprised of the five largest banks: Bank of New York Mellon Corporation, Wells Fargo, Citigroup Inc., Bank of America and JP Morgan Chase & Company.


  • What are the most common ETFs that track the banking sector?
    A:

    Some of the exchange-traded funds (ETFs) that track the banking sector are financial ETFs with varying degrees of exposure to banks, while others are pure-play bank ETFs. Some ETFs focus on the international financial services sector, whereas others concentrate on U.S. banking segments such as major banks, regional banks or community banks.

    An ETF is a marketable security that tracks indexes, index funds, commodities or bonds, for example. Like mutual funds, ETFs are designed to reduce risk for shareholders through the use of diversification. Index mutual funds and most ETFs are passively managed, seeking to match the fund's performance to a specific market index before fees and expenses.

    However, in contrast to mutual funds, ETFs trade the same way as common stocks in stock exchanges. Unlike mutual funds, ETFs do not have the net asset value calculated at the end of each day, but ETFs are more transparent than mutual funds. Mutual funds typically disclose their holdings quarterly, whereas ETFs do so daily.

    Common ETFs in the global financial sector include KBW Bank ETF, iShares Global Financials ETF, SPDR S&P Global Financials Sector Index and SPDR S&P International Financial Sector ETF.

    As its name implies, KBW Bank ETF is a pure-play ETF for the banking industry. Before expenses, it attempts to closely match the returns and characteristics of the KBW Bank Index, an index of geographically diverse companies representing national money center banks and regional banking institutions.

    IShares Global Financials seeks to track the investment results of an index made up of diversified global equities in the financial sector. This fund offers exposure to companies providing financial services to both commercial and retail customers, including banks, investment funds and insurance firms.

    Common ETFs for tracking U.S. financial services companies include iShares U.S. Financials ETF, Financial Select Sector SPDR, Guggenheim S&P 500 Eq Wght Finl ETF, ProShares Ultra Financials and Vanguard Financials ETF.

    Financial Select Sector SPRD is home to dozens of stocks. Holdings include major U.S. money center banks such as Wells Fargo & Co, JPMorgan Chase & Co, Bank of America Corp and Citigroup. However, this ETF also has holdings in real estate investment trusts such as Simon Property Group as well as insurance providers such as MetLife and American International Group.

    For investors seeking to avoid investments in big banks, there are ETFs that specialize in U.S. regional or community banks. For example, SPDR Regional Banking ETF follows the S&P Regional Banks Select Industry Index.

    IShares U.S. Regional Banks ETF tracks the Dow Jones U.S. Select Regional Banks Index, giving investors exposure to around 60 stocks. This fund is concentrated on some of the big names in the regional banking industry, such as U.S. Bancorp, PNC and BB&T.

    SPRD S&P Bank EFT is not a pure regional bank ETF, but the majority of its assets are regional banks, with smaller allocations to thrift and mortgage finance companies, diversified banks and other diversified financials.

    For its part, First Trust NASDAQ ABA Community Bank Index holds positions in more than 100 small banks. Based on assets size, this ETF excludes all of the 50 largest banks and thrifts. It also excludes companies with credit card or international specializations.


  • What are the most common ETFs that track the chemicals sector?
    A:

    As of 2015, no exchange-traded funds (ETFs) exclusively track the chemical sector, but ETFs are available that track chemical companies alongside other manufacturing and materials companies. The top chemical ETFs include Market Vectors Agribusiness (MOO), Materials Select Sector SPDR (XLB), iShares DJ US Basic Materials (IYM), Vanguard Materials (VAW) and Powershares Global Agriculture (PAGG). These ETFs all include exposure to chemical companies.

    ETFs offer investors an opportunity to spread their investments across multiple companies, thereby reducing the risks associated with investment. These securities work similarly to mutual funds but are passively managed. In other words, ETFs do not have financial managers actively trading securities for the fund. Instead, ETFs track a sector just like an index. Rates of return for ETFs are similar to the whole sector's average return. Chemical ETFs, then, track the chemical sector and offer returns similar to the industry average. These ETFs also follow other manufacturing companies with substantial chemical use, which may interest investors looking to purchase chemical securities.

    XLB, IYM and VAW all have similar holdings, with significant proportions of their total holdings invested in Dow Chemical, DuPont and other chemical companies. MOO and PAGG focus on the agriculture sector and offer exposure to companies manufacturing chemicals for agricultural production. XLB is the most common materials sector ETF, managing assets of around $5.2 billion. A total of 32 securities are included in the fund, with Dow Chemical represented by approximately 10% of the fund. About 75% of the assets are within the chemical sector, so XLB tracks the industry fairly closely. IYM has 61 securities and is also around 75% chemical. The remainder of these two funds is invested in mining and materials sector companies. VAW, however, is 21.6% specialty chemical, with the rest of the fund heavily invested in diversified and agriculture chemicals along with raw materials companies.

    Many manufacturing companies rely heavily on chemical production and may provide additional investment opportunity. The automotive sector consumes 10% of all chemicals, and automotive ETFs may be another means of gaining exposure to chemical companies outside the sector. Agricultural businesses use products produced by the industry to increase crop yields. Electronics companies need chemicals for producing microchips, consumer electronics, industrial electronics and other electronic equipment.

    Growing consumer demand fuels growth in these industries and, by extension, increases chemical product demand as well. Investing in manufacturing ETFs may further reduce the risk of investing in one sector while providing exposure to the returns offered by the chemical industry. This option provides investors with additional investment opportunity outside the chemical sector while also investing in chemical companies.


  • What exactly is an ETF portfolio?
    A:

    An exchange-traded fund (ETF) portfolio is simply a portfolio, or group of investments, that consists entirely of ETFs. ETFs are very much like mutual funds in that they are a basket of stocks or other assets that are managed in either a passive or active investment style. Passively managed ETFs aim to mimic the performance of a particular market index, while actively managed ETFs aim to outperform a particular market index. ETFs are different than mutual funds in that they are exchange-traded throughout the day, providing intra-day liquidity for investors. Because ETFs trade on exchanges, investors can short them and buy or sell options on them.

    This flexibility may make a portfolio of ETFs more attractive to investors than portfolios of mutual funds. Due to the diversity of ETFs available to investors, almost any type of ETF portfolio can be constructed. There are ETFs available that cover almost every type of asset imaginable. Equity ETFs available include large cap, mid cap and small cap, as well as growth, value and blend styles among these various market capitalizations. Also, there are ETFs that track every major equity index in the U.S. and most developed countries.

    Beyond this, many different types of fixed-income ETFs track corporate bond, treasury bond, high-yield, international and emerging-debt indexes. Investors can also invest in real estate, commodity, alternative investment and currency ETFs. Lastly, many firms have leveraged ETFs that offer two or three times the return of an underlying index, as well as inverse ETFs that provide the opposite returns of an underlying index or asset.


  • What is the automotive sector?
    In the world of finance, the automotive sector represents the financial performance and economic variables related to automobile manufacturers, dealerships, original equipment manufacturers and auto maintenance companies. The U.S. Department of Labor recognizes the manufacture, sales, servicing and production of spare parts as part of the automobile industry. This sector includes the wholesale and retail sub-sectors dealing with the sales of vehicles and spare parts.

    The term "automotive sector" is used both in the automobile industry and the financial industry to refer to the companies that form the market sector and the financial products derived from their performance, such as stocks and exchange-traded funds. In the United States, the automotive sector's performance is greatly influenced by the automobile industry's big three manufacturers: General Motors, Ford and Chrysler. Consequently, the auto industry's performance also affects other major sectors such as transportation, oil, and food and beverage. In addition to manufacturers, this sector includes the manufacturers and resellers of auto parts, third-party servicing companies, manufacturers of trailers and tire stores. In the United States, each subsector of the automotive sector is recognized by the North American Industry Classification System.

    Consequently, the automotive sector is not limited to the manufacture of cars and commercial vehicles. It also includes specialized industrial vehicles and other capital equipment as well as automobile design, research and development, and auto finance. The sector also provides employment to professionals from several fields including administration, human resources, engineers, sales, marketing, health care, finance, accounting, retail, wholesale and management.

    The U.S. Automotive Sector

    The Organization Internationale des Constructeurs d’Automobiles ranks the United States as the second-largest producer of automobiles, second only to China in the number of motor vehicles produced per year. In 2014, the country's annual production of 11.66 million passenger and commercial vehicles is greater than the combined production of Germany and South Korea, the next two countries on the list, according to OICA's annual report.

    The Center for Automotive Research estimates that over 16 million units – including passenger, commercial and other vehicles – were produced that same year. In 2015, the U.S. automobile sector is estimated to be worth approximately $620 billion, contributing between 3% and 3.5% of the nation’s GDP, according to a research paper by CAR.

    The U.S. automotive sector employs over 1.7 million people and pays over $500 billion in annual compensation, and it is responsible for creating jobs in multiple sectors that support the automotive industry. OEM remains one of the largest subsectors created by the automobile industry, employing over 2.4 million people in manufacturing spare parts and accessories not directly manufactured by automakers. In 2014, it also contributed $206 billion to state and federal coffers in tax revenue.


  • What is the best way to get exposure to electric cars when investing in the automotive sector?
    A:

    Investors interested in electric cars have a variety of options. Automakers such as Tesla Motors exclusively manufacture electric vehicles and may be directly invested in by purchasing stock. Companies within the automotive sector that manufacture vehicle parts or supply raw materials used in producing electric cars are another means of gaining portfolio exposure to electric cars. Another slightly less risky option is to invest in exchange-traded funds (ETFs) with holdings in securities related to electric vehicle production or electric vehicle parts.

    Some major automakers, such as Toyota, are investing heavily in electric vehicles and allow investors to choose both traditional and electric vehicles for their investments. Chevrolet and Nissan have also made notable electric car models available in the U.S. market. Investors should carefully consider available investment opportunities and evaluate the potential risk return tradeoff offered by electric vehicles and the automotive industry.

    Many manufacturers develop auto parts for traditional and electric vehicles. Polypore International (PPO) produces lead acid batteries used in both conventional and electric vehicles. This stock offers investors the opportunity to invest generally in the production of vehicle batteries. As electric vehicle and conventional vehicle usage grows, more batteries will be needed and this company will likely benefit from increased global car demand.

    Another battery company, Plug Power (PLUG), manufactures hydrogen fuel cell batteries used in electric vehicles and many other types of electronic equipment. These batteries may replace lead acid batteries in fork lifts. Plug Power batteries are also used outside the automotive industry, giving the company a large market.

    Sociedad Quimica y Minera (SQM) is a major supplier of lithium, an element used in many batteries powering electric vehicles and other clean technologies. Investment in companies such as Polypore International, Plug Power and SQM offers portfolio exposure to electric vehicles while also maintaining diverse holdings outside the automotive industry.

    Exchange-traded funds that track electric vehicles are another possible opportunity for investors. These funds allow investors to purchase shares in funds that track electric vehicle industry development. Investments are spread across multiple companies, reducing investment risk and offering returns similar to the average returns of the entire sector. ETFs track gains and losses of stock indexes and are traded directly on the stock market in a means similar to stock trading. Just as in traditional stock trading, stop-loss limits may be placed and dividends are paid to brokerage accounts.

    Significant ETFs that include electric vehicle stock and supplier stock include QCLN and LIT. The First Trust NASDAQ Clean Edge Green Energy Index Fund (QCLN) has Tesla among its holdings and includes other companies with green technology offerings. Global X Lithium (LIT) tracks lithium suppliers and battery companies. This fund's most significant holdings include FMC Corporation, Avalon Rare Metals Incorporated and Rockwood.


  • What is the difference between an ETF's net asset value (NAV) and its market price?
    A:

    An exchange-traded fund's market price is the price at which shares in the ETF can be bought or sold on the exchanges during trading hours, while the net asset value (NAV) represents the value of each share’s portion of the fund’s underlying assets and cash at the end of the trading day. ETFs calculate the NAV at 4 p.m. EST, after the markets close.

    The NAV is determined by adding up the value of all assets in the fund, including assets and cash, subtracting any liabilities, and then dividing that value by the number of outstanding shares in the ETF. The NAV is used to compare the performance of different funds, as well as for accounting purposes. The ETF also releases its current daily holdings, amount of cash, outstanding shares and accrued dividends, if applicable. For investors, ETFs have the advantage of being more transparent. Mutual funds and closed-end funds do not have to disclose their daily holdings. In fact, mutual funds usually disclose their holdings only quarterly.

    There may be differences between the market closing price for the ETF and the NAV. Any deviations should be relatively minor, however. This is due to the redemption mechanism used by ETFs. Redemption mechanisms keep an ETF's market value and NAV value reasonably close. The ETF uses an authorized participant (AP) to form creation units. For an ETF tracking the S&P 500, an AP would form a creation unit of shares in all the S&P 500 companies in a weighting equal to that of the underlying index. The AP would then transfer the creation unit to the ETF provider on an equal NAV value basis. In return, the AP would receive a similarly valued block of shares in the ETF. The AP can then sell those shares in the open market. The creation units are usually anywhere from 25,000 to 600,000 shares of the ETF. 

    The redemption mechanism helps keep the market and NAV values in line. The AP can easily arbitrage any discrepancies between the market value and the NAV during the course of the trading day. The ETF shares' market value naturally fluctuates during the trading day. If the market value gets too high compared to the NAV, the AP can step in and buy the ETF's underlying constituent components while simultaneously selling ETF shares.

    In the alternative, the AP can buy the ETF shares and sell the underlying components if the ETF market value gets too far below the NAV. These opportunities can provide a quick and relatively risk-free profit for the AP while also keeping the values close together. There may be multiple APs for an ETF, ensuring that more than one party can step in to arbitrage away any price discrepancies.


  • What is the difference between iShares, Vanguard ETFs and Spiders?
    A:

    iShares, Vanguard ETFs and spiders each represent different exchange-traded fund (ETF) families. In other words, an individual company offers a range of ETF types under one product line. Because these ETF families are constructed and operated by different companies, you will find differences in terms of how they are made up and what indexes or sectors they cover.

    BlackRock is the company behind the iShares family of ETFs. The company offers a large selection of more than 350 funds, which cover a wide range of both U.S. and international sectors and indexes, as well as asset classes, including bonds, real estate and commodities.

    The Vanguard ETF family, formerly known as the Vanguard Index Participation Receipts (VIPERs), is similar to iShares in that it offers a wide range of ETF types covering numerous indexes and sectors in more than 50 different funds.

    State Street Global Advisors' Spiders (SPDRs) are index funds that were initially based on the S&P 500 index, but branched out to include other investment options as their popularity grew. Some of the best-known spiders are the 10 Select Sector SPDRs that cover individual sectors of the S&P 500. (For more, see What are SPDR ETFs?)

    The differences between spiders, Vanguard ETFs and iShares are primarily based on the companies behind these ETFs and which indexes and/or sectors they cover. But if you are looking for exposure to the S&P 500, for example, which is offered by more than one ETF company, look at the more specific attributes of the fund. The biggest thing to focus on in this case will be the fund's expense ratio (a lower expense ratio is generally more desirable), along with how well the ETF tracks the underlying index. 

    For more insight, see the Exchange-Traded Funds Tutorial. 


  • What is the QQQ ETF?
    The PowerShares QQQ, previously known as the QQQQ, is a widely held and traded exchange-traded fund (ETF) that tracks the Nasdaq 100 Index.

    The Nasdaq 100 Index is composed of 100 of the largest international and domestic companies, excluding financial companies, that are listed on the Nasdaq stock exchange, based on market capitalization. Therefore, QQQ is heavily weighted toward large-cap technology companies and is often viewed as a snapshot of how the technology sector is trading. 

    As an ETF, as opposed to an index, QQQ is a marketable security that trades on an exchange, offering traders a way to invest in the largest 100 non-financial companies listed on the Nasdaq.

    The QQQ tracks the information technology, consumer discretionary, health care, consumer staples, industrials and telecommunication services sectors. QQQ is rebalanced quarterly and reconstituted annually.

    As of Feb. 14, 2018, the sector breakdown of QQQ was: 

    • Information technology: 60.44%
    • Consumer discretionary: 22.38%
    • Health care: 9.85%
    • Consumer staples: 4.42%
    • Industrials: 2.1%
    • Telecommunication services 0.81%

    The top 10 holdings of QQQ, as of Feb. 14, 2018, were:

    • Apple (AAPL): 11.25%
    • Microsoft (MSFT): 9.17%
    • Amazon.com (AMZN): 9.15%
    • Facebook (FB): 5.6%
    • Alphabet (GOOG) Class C shares: 4.89%
    • Alphabet (GOOGL) Class A shares: 4.19%
    • Intel (INTC): 2.78%
    • Cisco Systems (CSCO): 2.72%
    • Comcast (CMCSA): 2.41%
    • NVIDIA (NVDA): 1.92%

    Apple, by far the most important company for QQQ investors, has a market cap of around $900 billion — the largest in history. Apple has perfected the art of getting consumers into its ecosystem and not letting go, by upselling and releasing new versions of old products in order to keep revenue growing. 

    Microsoft, Google and Amazon are all highly innovative with strong operational cash flow. With the exception of Amazon, these top holdings all deliver consistently on the bottom line, which helps investors feel secure. Amazon, for its part, boasts rampant top-line growth.

    Those looking for an ETF that comes with a very low expense ratio (0.2%, as of February 2018) and tracks quality names, may want to consider QQQ.


  • What types of futures contracts are typically sold on an exchange?
    A:

    There are futures contracts available and traded on exchanges for virtually every class of investment asset, ranging from agricultural commodities to stock index futures.

    The earliest known futures exchange was established in Japan in 1710 for trading rice futures, although informal futures trading in metals took place in England as far back as 1571. The modern futures exchanges can be traced back to the beginning of agricultural commodity futures trading in the United States in the 1840s. The Chicago Board of Trade (CBOT) was formed in 1848 and remains one of the largest futures exchanges in the world.

    Initially, the primary futures contracts traded were agricultural commodities and metal, but trading in financial products has surpassed basic commodity trading and accounts for the largest dollar volume of futures trading.

    The main futures exchanges in the United States include the CBOT, the Chicago Mercantile Exchange (CME), the New York Mercantile Exchange (NYMEX) and OneChicago, which trades futures on single stocks and exchange-traded funds (ETFs). The main futures exchanges in London are the London Metal Exchange (LME) and ICE Futures Europe.

    Futures contracts are grouped by type. With the advent of trading in eurodollar futures in 1981, the CME quickly expanded trading in currency futures to include over 20 currencies. This initial trading on the CME is what eventually led to widespread foreign exchange trading worldwide.

    Energy futures contracts, including crude oil and natural gas futures, are traded primarily on the (NYMEX).

    Food and fiber futures products are also primarily traded on the NYMEX. This group of futures contracts includes coffee, cocoa, orange juice, sugar and cotton. Orange juice futures are heavily speculated upon during the winter months when unexpected freezes can damage significant portions of the expected crop. Cotton futures trading was a huge market in the U.S. beginning in the 19th century, and many of the most legendary speculators, such as Jesse Livermore and John "Bet a Million" Gates, made and lost fortunes trading cotton futures.

    Nearly all of the main agricultural commodities are still traded on the CBOT. Although corn was the initial agricultural product traded on the CBOT, soybeans and wheat have supplanted it as the most widely traded crops.

    Interest rate futures were first introduced by the CBOT in the 1970s and quickly became among the most heavily traded futures contracts. U.S. Treasury notes and bonds are now among the top five futures contracts traded in terms of both volume and dollar value.

    Livestock, namely cattle and hog futures, are traded on the CME. Live cattle futures are one of the top 20 most heavily traded futures contracts.

    Metals contracts, which include gold, silver and copper, are traded on the NYMEX. Gold futures remain one of the most popular futures contracts with speculators.

    As of 2015, among the most recent additions to futures contract trading are stock index futures, including the Dow Jones Industrial Average (DJIA), the S&P 500 Index and the Nasdaq 100 Index, along with a handful of real estate futures contracts. All of these are traded on the CME. The S&P 500 Index futures are the most heavily traded of this group.

    Finally, weather futures contracts are traded in order to provide risk protection against conditions resulting from adverse weather conditions.


  • What types of stocks have a large difference between bid and ask prices?
    A:

    The bid-ask spread is the difference between the highest offered purchase price and the lowest offered sales price for a security. The spread is often presented as a percentage, calculated by dividing the difference between the bid and ask by either the midpoint or the ask. In the case of equities, these prices represent the demand and supply for shares in the stock market. The primary determinant of bid-ask spread size is trading volume. Thinly traded stocks tend to have higher spreads. Market volatility is another important determinant of spread size. Spreads usually grow in times of high volatility.

    Trading volume refers to the number of shares of a stock that are traded in a given time period and measures the liquidity of a stock. High-volume securities such as popular exchange-traded funds (ETFs) or very large firms including Microsoft or General Electric are highly liquid, and the spreads are usually only a few cents. Many investors are looking to buy or sell shares of these companies at any given time, so it is easier to locate a counterparty for the best bid or ask price.

    Stocks with low volumes usually have wider spreads. Small companies frequently exhibit lower trading volume because fewer investors are interested in relatively unknown firms. Large bid-ask spreads on illiquid shares are also used by market makers to compensate themselves for assuming the risk of holding low-volume securities. Market makers have a duty to engage in trading to ensure efficiently functioning markets for securities. A wide spread represents a higher premium for market makers.

    Volatility measures the severity of price changes for a security. When volatility is high, price changes are drastic. Bid-ask spreads usually widen in highly volatile environments, as investors and market makers attempt to take advantage of agitated market conditions.


  • Where can I find the P/E ratios for the Dow and S&P 500?
    A:

    The price-to-earnings (P/E) ratio is one of the most frequently used and trusted stock valuation metrics. It is calculated by dividing a company's share price by its earnings per share. This provides a measure of the price being paid for the earnings. A high P/E ratio signifies greater investor confidence in a company's future prospects, but it can also be a sign shares are overvalued.

    A company's P/E alone doesn't give a full picture of how expensive a stock is. It is important to look at it relative to the company's industry or a broad market index such as the S&P 500 or Dow Jones Industrial Average (DJIA).

    Many financial websites have P/Es for individual companies, but not for indexes like the Dow or S&P 500. And while some websites do contain P/E ratios for indexes, the accurate P/E ratio of an index, which is the index's total price divided by its total earnings, can sometimes be difficult to obtain. Some calculations or listings of an index's P/E ratio do not include companies in the index that have negative earnings, or they fail to factor in the weighting of the index. Typically, to get an accurate P/E reading, analysts and investors need to go to the index publisher's website.

    The most accurate P/E ratio for an index will be found if an investor calculates the P/E ratios of all equities that make up the index. Since that can be a time-consuming process, some investors prefer to accept the approximation provided by the P/E ratio of an exchange-traded fund (ETF) that closely tracks the index in question. While this measure is not as exact as the index's own measure, the information is a lot easier to find. For example, those who want to know the P/E ratio of the S&P 500 can look at the SPDR S&P 500 ETF (SPY), and for the Dow, investors can consult the SPDR Dow Jones Industrial Average ETF (DIA).

    There is likely to be some discrepancy between an ETF's P/E ratio and that of the index itself. This discrepancy is due to the fees charged on an ETF, along with the fact that ETFs are traded on the stock market. Fluctuations in the price of the ETF are affected by both the underlying index and the regular price movement of the ETF, which acts like a stock. Further variation can result from the fact that the ETF's holdings may not precisely match the index's equity makeup. That said, the return on an ETF is often very close to that of the index, and an ETF's P/E ratio often provides a good approximation for the P/E of the index it tracks.

    For further reading, see Understanding the P/E Ratio and Introduction to Exchange-Traded Funds.


  • Which benchmarks / indexes track the automotive sector?
    A:

    Some of the benchmark indexes that investors can use to track the performance of the automotive sector are the Nasdaq OMX Global Auto Index, the S-Network Global Automotive Index, the MSCI ACWI Automobiles and Components Index, and the STOXX Europe 600 Automobiles & Parts index. Other useful benchmark indexes that are not solely focused on the automotive industry but that include a significant percentage of auto industry stocks are the S&P Consumer Discretionary Select Sector Index and the Dow Jones U.S. Consumer Goods Index.

    Benchmark indexes are composed of a sampling of securities designed to represent the overall performance of a selected market sector. Benchmarks are a valuable tool for analysts and investors in assessing the health of various market sectors and also in evaluating the performance of an investment portfolio. Sector and Industry indexes can be compared to major market indexes, such as the S&P 500 Index, to see how well a segment of the market is performing compared to the market as a whole. Index returns provide good comparison points for investors to evaluate a specific portfolio, funds or individual stock selections.

    The Nasdaq OMX Global Auto Index

    The Nasdaq OMX Global Auto Index uses a specific market capitalization weighting methodology to more accurately mirror the performance of the largest and most widely traded automotive manufacturing firms. This benchmark is the basis for one of the major auto industry exchange-traded funds (ETFs), the First Trust Nasdaq Global Auto Index Fund.

    The S-Network Global Automotive Index

    The S-Network Global Automotive Index is a broader automotive sector index than the Nasdaq QMX. In addition to the major auto manufacturers, it includes an extensive selection of stocks of companies that manufacture and market auto parts or that provide auto-related services. Like the Nasdaq index, the S-Network Global Automotive Index is a modified market capitalization weighted index. The index is designed to include the 50 largest, most frequently traded global companies that derive at least 50% of their revenues from the automobile industry.

    The MSCI ACWI Automobiles and Components Index

    The MSCI ACWI Automobiles and Components Index is made up of a mix of mid- and large-cap stocks from 23 developed countries and 23 emerging market nations. All of the equities contained in the index are classified as being within the Automobiles and Components industry group within the larger consumer discretionary sector. The index includes Toyota, Ford, Daimler, and major auto parts suppliers Bridgestone and Johnson Controls.

    The STOXX Europe 600 Automobiles & Parts Index

    The STOXX Europe 600 Automobiles & Parts Index measures the performance of the major European automotive manufacturers and auto parts supply firms. It is an industry subset of the STOXX Europe 600 Index, which is composed of 600 of the largest and most widely traded stocks in 18 European countries. Tire manufacturers Pirelli and Michelin are significant elements of this index.


  • Who's in charge of managing exchange-traded funds?
    A:

    An exchange-traded fund (ETF) is a security that tracks an index but has the flexibility of trading like a stock. Just like an index fund, an ETF represents a basket of stocks that reflects an index. The difference is that an ETF isn't a mutual fund - it trades just like any other company on a stock exchange. The high management fees and the lack of liquidity of index mutual funds have made ETFs increasingly popular investment vehicles. Almost every one of today's major indexes has an ETF tracking its performance, and most ETFs are passively managed by some form of trust company. These trust companies take on the responsibility of maintaining the portfolio of stocks within the index to which they are linked. The trust company transforms the portfolio into individual shares of ETFs, which are then sold and purchased on the AMEX like regular stocks, such as the Spiders and Diamonds ETFs.

    Even though ETFs are passively managed and mimic a specific index, charges are incurred for these services. These charges are typically lower than those of index funds and are used for day-to-day operations, maintenance of the index portfolio, and payment of employee salaries. Part of the maintenance of the portfolio entails the collection and safekeeping of dividends paid by companies within the index portfolio. It is the duty of the trust companies to distribute these payments to the ETF stockholders; the distributions are normally made on a periodic basis.


  • Why are MLP ETFs so expensive?
    A:

    A master limited partnership (MLP) is a specific type of limited partnership that is publicly traded. Under this legal structure, limited partners are the investors who provide the capital to the MLP in return for income distributions from the MLP’s cash flow. The general partner can be considered the fund manager and is responsible for the management of the fund, a task for which he receives compensation.

    An MLP is a unique investment opportunity in that it combines the tax savings of a limited partnership and the liquidity of a stock. MLPs are also unique because they need to derive 90% or more of their income from activities related to real estate, commodity or natural resources.

    Combining the concept of an MLP with that of an exchange-traded fund (ETF), MLP ETFs are market-traded assets that mitigate the excess paperwork associated with being a limited partner. MLP ETFs also mitigate risk through diversification. Each MLP ETF is essentially an ETF that invests in a specific group of MLPs — some focus on real estate, and others focus on oil pipelines or infrastructure MLPs.

    Unique Structure

    An MLP ETF is a unique structure that’s designed to deliver good income to its investors without the hassle that comes from being a limited partner of the fund itself. As a part of the complex structure, the ETFs themselves are often considered C-corporations and are subject to income taxes that the MLPs themselves are not.

    For comparison, most ETFs are structured as regulated investment companies and are not subject to the same tax liabilities that C-corporations are. The reason for the different structures goes back to restrictions on limited partnership ownership.

    Under government regulations, a normally structured ETF is not allowed to have more than 25% of the funds’ assets in limited partnership interests. Of course, an MLP ETF would essentially be 100% invested as a limited partner to the various MLPs the fund holds.

    C-corporations do not have these same restrictions and were, thus, chosen as the legal structures for these unique ETFs. The trade-off for being 100% invested in limited partnership interests was to accept a higher tax liability. Since an MLP ETF is structured as a company, the income it receives from its investments is taxed before it is given to the fund’s shareholders.

    Double Taxation

    The standard tax rate for corporations in the United States is 35%, and this rate is applied to MLP ETFs, which increases the fund’s expense ratio beyond the standard fees charged by the fund manager.

    Once the ETF pays out dividends to its shareholders, they will also be individually liable for the income taxes on the revenue, which indirectly increases the overall cost to investors.

    In this way, it can be seen that the combination of an MLP and ETF offers the diversity of an ETF with the income of an MLP, but the legal structure necessary to make an MLP ETF viable creates tax liabilities to the fund and investor that makes it an expensive investment.


  • Why can you short sell an ETF but not an index fund?
    A:

    To answer this question, we should first define exactly what an index fund is. An index fund is a mutual fund, or a basket of stocks sold by a mutual fund company, that attempts to mimic or trace the movements of a given index.

    You can buy index funds for numerous different indices, including the S&P 500, the Dow Jones Industrial Average and the Russell 2000. With an index fund, you are buying ownership into a portion of a portfolio composed of stocks that are weighted in such proportions as to track a desired index.

    A trader engages in shorting when he or she borrows a security, usually from a broker, and then sells it to another party. The short seller hopes the security's price will go down so that he or she can pay a lower price when buying back the security to return it to the lending party. If successful, the short seller will profit from the difference between the price at which the security was sold and the lower price at which it was bought back. Because you purchase and redeem mutual fund units from the mutual fund company and (generally) not on the open market, you can't short an index fund.

    However, as technology has evolved in other areas of the economy, it has also done so in the financial sector. The need for an index-tracking, stock-like security was recognized and the security known as an ETF, or exchange traded fund, was born. An ETF's value is tied to a group of securities that compose an index. Investors are able to short sell an ETF, buy it on margin and trade it. In other words, ETFs are traded and exploited like any other stock on an exchange.

    ETFs attempt to track a given index, so they fluctuate in price throughout the day as the index fluctuates in value. However, as an ETF's price depends on the forces of supply and demand (which change with the movement of the underlying index), an ETF might not track the market in perfect unison, but most come very close.