CFA Level 1 - Alternative Investments
- Allows investors to diversify very easily by buying or selling the shares. As mentioned earlier, an ETF can cover an index no matter how big or small that index is.
- They trade on an exchange and can be sold short or margined.
- ETFs trade throughout whole day, so prices are always updated, while mutual funds only have a price at the close of the day.
- Trading futures and options on ETFs helps manage the risk involved in trading ETFs.
- ETF holdings are transparent. The sponsor posts the fund's holdings daily, which should mimic the index, while a mutual fund may disclose the fund's portfolio composition only on a yearly basis.
- They are cost effective, don't charge load fees and are passively managed, while mutual funds may have substantial fees and are often actively measured, which increases the expense ratio compared to ETFs.
- Their structure prevents any type of premium or discount forming because of the arbitrage effect of the futures and options on these securities. A closed-end fund, on the other hand, has a limited amount of shares, which can cause it to become overpriced as a result of its supply and demand attributes.
- ETFs mitigate capital gains exposure.
- Dividends are reinvested immediately for open-end ETFs.
- In many countries, the basket of securities that the ETF tracks may be limited.
- Many investors do not need the intraday trading activity of the security.
- Bid/ask spreads may be large because of the light trading that may occur in specific ETFs.
- Due to their size, large institutions may want to invest directly in the index or actively invest in the index, which could lead to lower cost and a better tax situation.
The following article provides further details about the advantages to ETFs: Advantages of Exchange-Traded Funds.