Understanding Exchange Traded Funds

Exchange Traded funds (ETFs) have become the fastest growing segment of securities in the markets over the past decade both in their numbers and their assets. But what are ETFs and why have they become so popular? Much of the reason lies in the same reason why mutual funds became so popular...diversification in one investment. The advantages of diversification have long been highlighted but they become even more pronounced during market downturns and enhanced market volatility. Like mutual funds, ETFs represent a portfolio of securities that adhere to a particular investment strategy, index or industry sector. Unlike mutual funds, ETFs generally do not have actively managed portfolios, have significantly lower expense ratios than most actively managed mutual funds and can be traded during open market hours like a stock without the unmitigated downside risk that non-diversified securities retain.

At Capital Income Management (CIM), we utilize ETFs in conjunction with CEFs because CEFs will often correlate with similar indexes that ETFs follow but at a discount or premium price. Analyzing these two securities together can give investors an advantage based on these relative valuation differences. CIM will use ETFs in long positions in our client portfolios as well as hedged positions with CEFs. Hedged positions are most important during difficult market periods to give portfolios downside protection.

ETFs have quickly become one of the primary investments of choice for many institutional asset managers because of their size and liquidity. Many ETFs include some of the most heavily traded securities on the NYSE and other global stock exchanges and include some of the biggest financial names as well.