Exchange Traded Fund (ETF) is form of investment instrument that provide numerous possibilities. It is a fund that tracks an index, but can be traded like an equity instrument. ETFs always bundle together the securities that are in an index. It holds assets such as stocks or bonds and trades at approximately the same price as the net asset value of its underlying assets over the course of the trading day. Investors can do just about anything with an ETF that they can do with a normal equity instrument. Since, it is traded on stock exchanges, it can be bought and sold at any time during the trading day, it experiences price changes throughout the day as they are bought and sold. It is an attractive investment because it is easy to purchase a broad basket of securities in a single transaction and also offer the convenience of a stock along with the diversification of a mutual fund. ETF is an investment product representing a basket of securities that track an index such as the NSE-30 Index. ETFs, which are available to individual investors only through brokers and advisers, trade like stocks on an exchange.
Due to the volatility of the stock prices, it will be of an advantage to investors to spread their investments thereby lowering the risk of price crash. ETFs provide the investor from individual price crash by investing in a basket of stocks or commodities. ETFs allow the investor to buy or sell a basket of stocks or commodities either in an industry such as NSE Food and Beverages or across border as in NSE 30 with convenience of a stock and still get diversification benefits. ETFs can also be used as a retirement investment strategy.
ETFs do not sell securities to the investors rather they issue large blocks know as creation of units which are sold to market makers or institutional investors, these units are placed in a trust and split and then sold in the secondary market. When an investor purchases a unit of an ETF in the secondary market, he is basically investing in bundle of the underlying securities, usually represented by an index which maybe sectorial or across the borders of all quoted or unquoted companies/products like NSE 30; NSE Food and Beverages; NSE Banking; NSE Insurance or NSE Oil and Gas.
Unlike regular mutual funds, ETFs do not necessarily trade at the net asset values of their underlying holdings. Instead, the market price of an ETF is determined by forces of supply and demand for the ETF shares. To a large extent, the supply and demand for ETF shares are driven by the underlying values of their portfolios, but other factors can and do affect their market prices. As a result, the potential exists for ETFs to trade at prices above or below the value of their underlying portfolios.
This gives the arbitrageurs an incentive to purchase additional units from the ETF and sell the component ETF shares in the open market. The additional supply of ETF shares increases the ETF's market capitalization and reduces the market price per share, generally eliminating the premium over net asset value. A similar process applies when there is weak demand for an ETF and its shares trade at a discount from net asset value. To liquidate their holdings investors simply sell their ETF shares in the open market or with an in-kind transaction, in which the investor does not get cash but the underlying stocks.
The NewGold ETF listed on December 19, 2011 is the latest example of an ETF currently trading on The Nigerian Stock Exchange. Its underlying asset is Gold Bullion Debenture. The launch of the NewGold is expected to give rise to other forms of ETFs in the market which may track the NSE-30 and NSE Food & Beverages indices.