Understanding ETF

What is an ETF?

ETF, or exchange-traded fund is a collective investment scheme that invests in a basket of stocks, bonds, commodities, or other securities to mirror the performance of the index that it tracks. ETFs are unique as they can be traded like a common stock on the stock exchange – and also experience price changes throughout the day as they are bought and sold.

Why invest in ETFs?

Low Cost — ETFs are typically passive solutions; which allows it to be a cost-effective investment option. Management fees are comparatively lower as compared to actively-managed funds, and it does not impose any sales charge.

Tradability — Similar to stocks, ETFs can be bought or sold anytime throughout the regular trading hours on the stock exchange.

Diversification — ETF stands out as a versatile investment tool; offering investors the benefit to gain broad exposure into a wide range of securities and markets in a single transaction. Additionally, specialised ETFs like commodity ETFs can also be adapted to complement one’s core portfolio for an added diversified edge.

How do ETFs work?

ETF units are first created in the primary market before trading in the secondary market can take place. In most cases, the mechanics of an ETF involves the interaction between the following participants:

  • Manager of the ETF — such as Affin Hwang Asset Management Berhad.
  • Participating Dealers (“PD”) — they act as the distributer of the ETF for institutional investors who wish to subscribe via the primary market. PDs are usually brokerage firms that are authorised to create and redeem units.
  • Market Makers — also refers to parties that are authorised to create and redeem ETF units in the primary market. However, their main role is to provide liquidity by facilitating trades in the secondary market.

PDs function as distributers for the ETF, and have a more prominent role in the primary market. Institutional clients who intends to subscribe into an ETF in substantial amounts may invest directly via PDs. Investing through PDs however would typically have a minimum creation / redemption basket; which may be in the range of hundreds of thousands of units.

On the other hand, Market Makers are essentially the liquidity providers for any ETF – ensuring that there is always a bid and offer quote at which to trade on the exchange. They would first apply to the Manager of the ETF for the creation of units in the primary market. After completing the direct purchase, the already created units can then be sold in smaller lots to individuals / retail investors in the secondary market (i.e. stock exchange). Their role is also to ensure that the market price of the ETF does not deviate too much from its underlying index.

How to invest in ETFs?

Via Participating Dealer (“PD”)
ETF units may be created / redeemed at NAV in the primary market via PDs. This is typically for institutional investors, where investments are usually of larger denominations.

Via Stock Exchange
Individual / retail investors can buy and sell ETF units at market price during the regular trading hours of the exchange. In Malaysia, investors would need a CDS (“Central Depository System”) account and a trading account with a Participating Organisation (i.e. brokerage firms registered in Malaysia) to invest.

Comparison between ETFs, Stocks, and Unit Trust Funds
ETF Stock Unit Trust
(including index funds)
Trade via Broker Broker Agent
Initial Fee Brokerage fees apply consisting of clearing fees and stamp duties where applicable Brokerage fees apply consisting of clearing fees and stamp duties where applicable Upfront sales commission between 3.00% to 5.00%
Annual Management Fee Typically less than 1% of the fund’s NAV n/a Typically between 0.75% to 5.00% of the fund’s NAV
Diversification Yesn/aYes
Pricing Intraday

Investors can execute trades throughout the day during normal market hours
Intraday

Investors can execute trades throughout the day during normal market hours
Once a day, at close of business

All purchases or redemptions are entered based on a single price at the end of the trading day