ETF Questions. Help!

📊 Investing
1

Good morning everyone,

I have some questions on ETF’s as I can’t quite get my head around them.

  1. Is it the performance of the companies held in the ETF that influence the price fluctuations or is it the ETF being traded that makes the share price go up and down?

  2. When you buy shares in an ETF, do you actually ‘own’ a small % of the Companies held in it?

Your advice in appreciated!

2

Hi @TradingSam. Good questions.

  1. The answer to the first question is “sort of”. It is linked to the NAV. Here is a link to a good explanation.

https://www.ishares.com/ch/individual/en/education/etf-pricing-and-valuations?switchLocale=y&siteEntryPassthrough=true

  1. You don’t own the underlying assets when buying an ETF.
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3

That is very helpful. Thank you! Makes sense now.

4

Is the answer to 2, not more you own shares in the ETF, which in turn own’s a share of its underlying constituent companies. So indirectly yes you do.

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5

I suppose it depends by what is meant by own. When you buy shares through a nominee you are still the beneficial owner but not the legal owner of the shares. When you buy a share of an ETF you are the beneficial owner of that share. But you have no rights with regards to the underlying assets.

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6

Most of what I’m saying was already said in the source or by others but let me add with the authorized participant (AP). An AP is a market maker or any other large financial institution with a lot of buying power. Let’s disregard the initialization of the ETF and look at when it’s already trading:

  • the ETF is at nav
  • the ETF is discounted to nav
  • the ETF has a premium to nav

If the ETF is at nav what you’re paying for your ETF is the same as if you would’ve bought the underlying in the same proportions that your ETF has. AP did his/her job!

But it can also happen that a lot of people buy or sell the ETF while the underlying assets aren’t bought/sold in the same proportions. A discount (ETF trades bellow nav) or premium (ETF trades above nav) can be bad for buyers/sellers of the ETF as the price they’re paying or receiving isn’t the true price of the underlying. Discount, for example, could be good for buyers but is bad for sellers, vice versa for the premium to nav.

This discount/premium to nav is bad for the integrity of the ETF, but luckily we have APs. When the AP sees a premium the AP might buy up the underlying shares that compose the ETF and then sell ETF shares on the open market (if the AP doesn’t hold any ETF shares they exchange the underlying for newly issued ETF shares which they then sell). This should help drive the ETF’s share price back toward fair value, while the AP earns a basically risk-free arbitrage profit. The inverse happens with a discount (buying ETF and then redeeming it for the underlying which they sell). The process is nicely laid out in the infographic below.

image
image934×773 132 KB

The AP earns almost risk-free money through arbitrage and makes a more efficient market. (fun fact: that’s why ETF units always are nice round numbers)

Sources for further education:
https://www.etf.com/etf-education-center/etf-basics/what-is-the-creationredemption-mechanism?nopaging=1
https://www.etf.com/etf-education-center/etf-basics/understanding-premiums-and-discounts?nopaging=1

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7

This also explains the tax disadvantage. When an ETF receives an Apple dividend it pays 15% withholding tax to the US, and only the net is available for distribution. But the ETF investor still has to pay a second tranch of UK tax on the ETF dividend with no foreign tax credit available to take. So he receives 0.85*0.675 =0.535 (32.5% dividend tax rate for higher rate taxpayer) rather than 0.676 that he would have netted of he had been invested in AAPL directly. The taxpayer cannot take a credit for the US withholding tax paid because he is not the actual owner of the shares when the dividend was paid. Similarly, when buying an ETF of UK shares like VUKE there is no 0.5% stamp duty to pay. The stamp duty is paid by the ETF issuer.

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8

Thank you for your explanations, it’s very helpful and appreciated. :+1:

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Thank you @Richard.W, your info is appreciated. :+1:

11

So if you’ve got an ETF like INRG which ‘tracks the performance of an index composed of 30 of the largest global companies involved in the clean energy sector’ will the share price of the ETF change based on what the prices of the underlying stocks are doing? Or does the share price fluctuate based on it being bought and sold by investors? Or somehow both and the price is an interaction of the underlying stock prices and the actual ETF being bought and sold?

I’ve read about ETFs but don’t quite understand it. For instance, if no one is buying the ETF will the price just not change even if the underlying stock prices are?

Thanks.

12

Here’s a great explanation of ETFs:
Exchange Traded Fund (ETF): What an ETF Is and How to Buy Them.

13

Thanks it was actually something I read in that Investopedia page that confused me. The bit from the ‘Key Takeaways’ below where it says ‘ETF share prices fluctuate all day as the ETF is bought and sold’.

Am I right in thinking this is just minimal fluctuations based on buying/selling pressure and it doesn’t significantly change the ETF price determined by the ETFs underlying stocks?

KEY TAKEAWAYS
An exchange traded fund (ETF) is a basket of securities that trade on an exchange, just like a stock.
ETF share prices fluctuate all day as the ETF is bought and sold

14

This has been discussed in another thread recently, so I am moving the above posts there.

There are some interesting issues currently with INRG, being written about in Financial Times.

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