Exchange Traded Funds (ETFs) are passively managed and open-ended funds. All listed ETFs on the HKEX securities market are authorised by the Securities and Futures Commission as collective investment schemes. ETFs are designed to track the performance of their underlying benchmarks (eg an index, a commodity such as gold, etc) and offer investors an efficient way to obtain cost-effective exposure to a wide range of underlying market themes. Similar to other securities, investors can buy or sell ETFs through their brokers anytime during the securities market’s trading hours.
ETFs can be broadly grouped into two types:
1. Physical ETFs (ie traditional or in-specie ETFs)
Many of these ETFs directly buy all the assets needed to replicate the composition and weighting of their benchmark (eg constituents of a stock index). However, some only buy a portion of the assets needed to replicate the benchmark or assets which have a high degree of correlation with the underlying benchmark but are not part of it.
Some physical ETFs with underlying equity-based indices may also invest partially in futures and options contracts. Lending the shares they own is another strategy used by some physical ETFs. Investors should read the ETF prospectus carefully to ensure they understand how the fund operates.
2. Synthetic ETFs
These ETFs do not buy the assets in their benchmark. Instead, they typically invest in financial derivative instruments to replicate the benchmark’s performance. The ETFs are required to have collateral when investing in derivatives (details of the net and gross counterparty exposure and types and composition of the collateral are published on the ETF’s website). An ETF’s net risk exposure to any single counterparty (ie net of the value of any collateral provided) cannot be more than 10 per cent of its NAV. Investors should read the ETF prospectus carefully to ensure they understand how the fund operates.