Exchange Traded Funds
Explore answers to some of the most commonly asked ETF questions
An exchange-traded fund (or ETF) is an open-ended investment fund that you can trade on a stock exchange like the Australian Securities Exchange (ASX) or Cboe Australia, just like direct shares. When an investor purchases an ETF they receive units in the ETF, gaining access to the underlying assets that the ETF invests into, rather than owning the underlying shares or assets themselves.
ETFs can be actively or passively managed. Passive ETFs typically track the performance of an index, benchmark, sector or commodity. Active ETFs have a strategically selected underlying portfolio that is actively managed by a professional fund manager with the aim of achieving its investment objectives.
Active ETFs are actively managed by an investment manager – typically with the aim of outperforming a market benchmark or achieving a specific investment objective. Active ETFs give investors access to experienced, active investment management specialists. Allowing investors to build portfolios and invest in ways that are suitable for their individual investment objectives and risk tolerances.
Active ETFs, like all ETFs, are open-ended funds, which means that the ETF issuer can create or redeem units according to investor demand and investors are generally able to buy or sell these units on the exchange during each trading day.
A passive or index (also known as index-tracking) ETF typically aims to replicate the performance of a specific index. They may be designed to track a standard index such as the S&P/ASX 200 or a custom benchmark tailored to a specific thematic. The value of the ETF typically goes up or down in line with the index that it is tracking and, in general, the ETF does not aim to outperform that index.
In contrast, active ETFs are based on a particular active investment strategy, and their underlying investments are chosen by the investment manager of the active ETF according to that strategy. The investment strategy employed by the Investment Manager may aim to outperform an index or market sector or to achieve a certain investment return or risk objective and the Investment Manager may employ various trading and portfolio management strategies to try to meet this objective.
Market Makers are broker dealers that have agreed with the ETF issuer that they will provide, subject to certain exceptions, two sided (that is, buy and sell) quotes to ETF investors on the relevant stock exchange for a majority of each trading day. In other words, the Market Maker’s role is to help facilitate liquidity for units in the ETF on the exchange.
Authorised Participants (APs) are trading participants of an exchange, such as the ASX, that are permitted under the rules of the exchange to buy and sell units in the ETF on the exchange during the trading day. The APs then generally cover their trades on the exchange by creating or redeeming units with the ETF issuer. In other words, the APs will redeem units with the issuer if they have bought units on the exchange during a trading day and apply for more units to be created if they have sold units on the exchange during a trading day. This process adjusts the number of ETF units on issue and assists in keeping the market price for units in an ETF broadly aligned with the NAV per unit price. Each AP typically enters into an agreement with the ETF issuer that governs the process for creating and redeeming units with the ETF issuer.
To fulfill their role as liquidity providers for the ETF, the Market Makers will either need to be APs themselves or appoint APs to act for them. As an ETF grows in size, additional APs (who are not Market Makers or acting for Market Makers) may look to trade in the ETF’s units on a voluntary basis.
When you invest into an active ETF, like with passive ETFs, you do not own the underlying investments in which the active ETF is invested. You instead own units in the active ETF. The Issuer of the active ETF owns the relevant underlying assets (such as shares), which it holds on trust for all unitholders.
The indicative Net Asset Value (iNAV) is an indicative estimate of the intraday value of a unit in the ETF and is based on the estimated market values of the ETF’s underlying net assets. It is available for certain ETFs. Where available, the iNAV is a useful tool that can be used by investors to provide them with an indication of the current value of a unit in the ETF.
The iNAV is independently calculated and is published on the Macquarie website throughout each trading day (at least every 15 seconds). A standardised Portfolio Composition File (PCF), which contains up-to-date portfolio information on the ETF, is provided to our iNAV provider each trading day and is used by the iNAV provider to calculate the iNAV. The PCF file includes the most recent closing net asset value for the ETF as well as the holdings of the ETF. These inputs are combined with real-time security prices to arrive at the iNAV for the ETF.
For listed equity securities, the most recent trade price from the exchange is used throughout the equities trading day in the iNAV calculation. When the exchanges are closed, the securities can be priced using the iNAV provider’s proprietary real-time fair valuation service which adjusts each security for post-closing market movements. This service uses a multi-factor model to calculate the real-time estimates of the price for an equity security utilising information such as the local closing prices, relevant general and sector indices, currency fluctuations and futures.
It is important to note that the iNAV is an estimate only and is only intended to be an indication of the current value of a unit in the ETF, rather than a definitive statement of the value of the ETF. No assurance can be given that the iNAV will be up-to-date or accurate.
The Net Asset Value (NAV) per unit is the market value of the ETF’s underlying assets, less any fees, expenses and other liabilities incurred by the ETF. The NAV is calculated as at the end of each trading day and reflects the value of the ETF’s underlying net assets at the end of that trading day. The NAV per unit can also be used as a guide when evaluating the latest bid or ask price for a unit in the ETF that is quoted on the exchange.
The indicative Net Asset Value (iNAV) is an estimate of the intraday value of a unit in an ETF. Where available for an ETF, the iNAV gives investors an indication of the value of a unit in the ETF throughout the day, rather than at the end of the day as the NAV per unit does. However, unlike the NAV per unit, the iNAV is an estimate only and will be based on estimates of the value of assets for which there are no live price at the time of calculation (e.g., securities on an exchange that is closed at the time of calculation).
Both the NAV and iNAV are useful tools used by investors to give them an indication of the current value of a unit in an ETF.
Units in an ETF are purchased and sold on a stock exchange such as the ASX throughout the trading day. There are a number of reasons why the market price for units in an ETF on the exchange may differ from the last NAV per unit published by the ETF issuer.
The ETF issuer’s website will include information on the performance of the ETF over different time periods, based on the NAV per unit prices of the ETF.
You should also be able to obtain information on the performance of your individual holding in an ETF via the information or reporting provided to you by your broker or trading platform.
Please note that the performance of the ETF may differ between these two information sources, because the performance of your individual holding in an ETF will be based on the price(s) at which you bought and sold units in the ETF on the exchange whereas the performance of the ETF shown on the ETF issuer’s website is based on the NAV per unit price. Of the two sources, the individualised information from your broker or trading platform will show you the actual performance of your holding, with the performance information from the issuer website being a supplementary source of information.
ETFs (and other investments that are traded on an exchange, such as shares) are subject to bid/ask spreads. The bid/ask spread is the difference between the price at which participants are willing to buy units (the bid price) and the price at which participants are willing to sell units (the ask price).
When you assess how closely the units in an ETF are trading to its NAV per unit or iNAV (where it is available), you should take account of this bid/ask spread, which may result in the bid price for units on the exchange being lower than the NAV per unit or iNAV and the ask price for units on the exchange being higher than the NAV per unit or iNAV.
The NAV per unit for an ETF is published each trading day and is based on the value of the ETF’s underlying assets minus fees and other expenses. Because ETFs offer live pricing on the stock exchange, you are in control of the price you buy and sell at. Just like trading shares, you can take the market price with a market order or set your price with a limit order. The latter gives you greater certainty over the price at which you will trade. As ETFs have open-ended structures, units can be created and redeemed based on supply and demand. The true liquidity of an ETF depends on the underlying liquidity of the assets held by the ETF.
The iNAV is a helpful tool for investors when it comes to trading ETFs. Investors can compare the iNAV to the price at which they can buy or sell ETF units on the market – if the values are close then the investor can elect to trade at that price.
Market Makers aim to ensure that sufficient inventory is available on the exchange each trading day so that there is sufficient liquidity available in order to meet buy and sell orders placed during the day. As ETFs have open-ended structures, units can be created and redeemed by market makers at the end of each day based on supply and demand for units on the exchange. In other words, if a market maker has sold units on the exchange, they can apply for the creation of new units in the ETF and, if they’ve bought units on the exchange, they can redeem them with the ETF issuer.
This means that the true liquidity of an ETF depends on the underlying liquidity of the assets held by the ETF. As long as the underlying assets of the ETF remain liquid, the ETF issuer should generally be able to create or redeem units in response to investor demand and market maker requests. However, if the underlying assets of the ETF become illiquid for some reason, then the ETF issuer may not always be able to create and redeem units in response to investor demand, which may impact the buying and selling activity of the market makers on the exchange.
When assessing an ETF, it is important to note that a low trading volume on the exchange does not necessarily mean there is low liquidity for the ETF units. Large trades (such as investments made by large institutional investors) are typically facilitated by the ETF issuer, who helps with the liquidity management during the execution of those transactions.
In order to protect the intellectual property embedded within their investment strategy, some active ETFs use what is known as a “partial disclosure” model.
Under a partial disclosure model, the active ETF typically discloses a selected portion of its holdings on each trading day in the form of a Proxy Basket or Material Portfolio Information (MPI) file, with the information being published to the active ETF issuer’s website. This differs from a full disclosure model, where the full holdings of the ETF are disclosed each trading day.
The Proxy Basket or MPI file is used by the Market Makers to calculate the trading price for the active ETF throughout each trading day. Since investors don't have visibility over the full holdings of the active ETF under the partial disclosure model, active ETFs that employ this model are also required to issue an iNAV at least every 15 seconds during each trading day to give investors an indication of the estimated current net asset value per unit in the active ETF.
ETFs will typically charge a management fee and sometimes will also charge a performance fee. The fees charged by the ETF will be set out in the ETF’s product disclosure document.
The fees charged by an ETF are set by the ETF issuer and will be different for each ETF, depending on the strategy. The fees are commonly calculated daily and deducted from the assets of the ETF by the issuer and reflected in the NAV per unit price of the ETF.
The ETF is also likely to incur transaction costs associated with the ETF buying and selling its underlying assets, either in response to the creation and redemption of units in the ETF or as part of the investment manager implementing its investment strategy for the ETF.
The fees charged by the ETF are separate from any brokerage fees charged by an investor’s broker or share trading platform when an investor buys or sells units in the ETF. In addition, as noted above, Market Makers will typically apply a bid/ask spread when they buy and sell units in an ETF on an exchange.
Active ETFs may provide investors with a payment of income or capital in the form of a distribution, although, like dividends, these are not guaranteed and will depend on the performance of the ETF. Distributions are paid to investors in a similar way to a dividend that an investor receives in relation to a share in a company. These distributions will vary for each active ETF depending on the type of investment strategy and type of assets held by the active ETF and can range from a monthly to an annual payment frequency.
You may elect to have your distributions for a Macquarie ETF paid directly into a nominated Australian financial institution account or to have your distributions reinvested as additional units. Elections will be effective in respect of the first distribution after receipt of the election provided the election is received by 5.00pm (Sydney time), or such time as we otherwise determine, on the distribution reinvestment plan election date for the relevant distribution period. If the election is received after this time, it will apply to the next distribution period. We will notify you of the distribution reinvestment plan election date for each distribution period through an ASX Market Announcement. Further information on how to participate in an ETF’s DRP can be found in the ETF’s product disclosure statement.
The price of an ETF is influenced by market forces. If the market is volatile, the ETF price will likely be too. Markets tend to be more volatile near open and close and this is when spreads generally widen. Prices at the beginning of a trading day are influenced by breaking and overnight news and then tend to normalise.
Based on these trends, the general view is to avoid buying or selling ETFs within the first 30 minutes or during the closing auction at the end of the trading day. In early trading there may be a lower volume of trading activity, in conjunction with economic data news and changes in market sentiment which can lead to higher market volatility and result in the ETF price not aligning closely with its NAV per unit price. The same may be said when trading in the closing auction (4pm to 4.10pm) where there is a heightened risk of trading an ETF at a price that is at a greater discount or premium to the underlying value of its assets than at other times of the day.
A market order is one in which an investor offers to buy or sell a given number of ETF units (or other securities) at the best price available to fill the order. Market orders are best used when it’s important the trade is executed rather than achieving any specific price.
A limit order, by contrast, has a price limit attached to it – it is an order to buy (or sell), at a pre-determined price. While a limit order gives you more control over the price to buy (or sell), which may be helpful when markets are volatile, they can expire if the price target isn’t met so there is a risk that the order may not get executed.
For relatively small orders in normal market conditions, the distinction between limit and market orders in practice may not make much difference. But in times of market volatility, the difference between these types of orders can matter greatly.
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