Some Answers to Your ETF Questions

Editor's Note: This story was originally published Sept. 12, 2003 on RealMoney

There's clearly a lot of interest in exchange-traded funds, and the folks at RealMoney are dedicated to covering this quickly growing area of the investment landscape. In that vein, here are answers to some of your ETF-related questions.


Question: I've heard a lot of talk comparing ETFs to mutual funds. What are the advantages of ETFs over mutual funds?

Answer: ETFs have a number of advantages vs. mutual funds:

  • Transparency: Mutual funds only report their holdings twice a year, so you never really know what the fund currently owns. With an ETF, however, this information is readily available; you always know the underlying stocks that you own.

  • Buying and selling flexibility: Mutual funds trade based on the day's closing net asset value, or NAV. ETFs trade throughout the day, just like a traditional stock. ETFs can also be sold short, while mutual funds cannot.

  • Tax efficiency: Mutual fund managers' trading creates a taxable event; ETFs tend to generate fewer capital gains.

  • Cost effectiveness: ETFs generally have much lower annual expense ratios than mutual funds, which significantly impacts total return.


Question: How can I determine which stocks are represented in a particular ETF? Could you provide links to a site that provides lists of the stocks that make up the ETFs?

Answer: One of the many advantages of ETFs and HOLDRs is transparency: You know what you're buying. As I mentioned earlier, mutual funds only disclose their largest holdings twice a year, which causes the data to be both stale and incomplete. Unlike mutual funds, however, investors in ETFs or HOLDRs can easily determine what they own.

Investors in any one of the HOLDRs can go to the HOLDRs Web site and find the stocks that make up their investment.

Most iShares ETFs fully replicate the index they are tracking. In other words, the ETF is composed of the same stocks with the same weightings as the index it tracks. Some iShares, however, invest in a sampling of stocks that make up the index. In either case, portfolio holdings are updated monthly on the iShares Web site.

More information about ETF holdings can be found at ETF Connect.


Question: Can you trade options on ETFs?

Answer: Many ETFs have options available. You can check with your broker to see if options are available for a particular ETF, but for iShares, you can refer to the iShares Web site. In the far right column of each "Fund Details" section is an indication of whether options are available for each ETF.

Question: Is there a comprehensive listing of ETFs or a place on the Web to look up all of the available ETFs?

Answer: Near the end of the "Market Week" section of Barron's, there's a list of ETFs and HOLDRs that trade on the American Stock Exchange, the New York Stock Exchange or the Nasdaq, along with some information about each one.


Question: What determines if a foreign ETF (like the iShares MSCI Japan Index Fund ( EWJ)) rises or falls? How much correlation is there to the U.S. market, or is it determined solely by what's happening in, say, the Japanese market? If it is Tuesday in the U.S., and the EWJ closes at $8, and then the Nikkei goes down big, does the EWJ automatically and percentage-wise open down that amount/percentage? Sometimes it does not seem to match and is in fact trading separately from what happens in Japan.

Answer: It's important to note that the iShares MSCI Japan Index Fund is not meant to track the Nikkei. The EWJ is designed to track the MSCI Japan Index, which is a capitalization-weighted index that monitors the performance of Japanese stocks. Again, this doesn't necessarily track the Nikkei, although it is a good proxy for Japan.

So to use your example, if EWJ closes in the U.S. at $8 and then the Nikkei sells off, presumably the MSCI Japan Index would decline too (although not necessarily). The next day in the U.S., EWJ would be trading down by roughly the same percentage that the MSCI Japan Index lost.

EWJ does track what is happening in Japan as measured by the MSCI Japan Index, not by the Nikkei.

Charles L. Norton is a principal of GNI Capital, Inc., a registered investment adviser that manages a hedge fund, GNI Partners, L.P., as well as discretionary private client accounts. Norton previously was a vice president in the equity research department of a New York-based hedge fund, where he was also a registered representative managing discretionary private client accounts. Prior to his experience on the buy side, Norton worked in the investment banking division of Salomon Smith Barney, where he was an analyst in the health care group. At the time this piece was written, neither Norton nor his fund had any positions in the securities mentioned in this column, though positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Norton cannot provide investment advice or recommendations, he welcomes your feedback.

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