ETF: arbitrage opportunities exist

This course is reproduced from Morningstar and has been partially revised by Futu.

Exchange traded fund refers to the fund that can be listed on the exchange, also known as ETFs (Exchang Traded Funds), which represents the investment portfolio of a basket of stocks. For domestic investors, this is still a strange new thing, so we only introduce some of its basic characteristics.

In the early 1980s, a new technology emerged on the New York Stock Exchange that allowed investors to buy and sell a portfolio (such as all constituent stocks of an index) at once by issuing a single trading order. This provides the basis for the emergence of exchange-traded funds.

01 flexible transaction and low cost

The key reason why this kind of fund is welcomed by investors lies in its advantages of flexible transaction and low cost.

Exchange-traded funds can be traded in two ways. First, investors apply for purchase and redemption directly from the fund company. This has a certain quantity limit, which is generally 50,000 fund units or integral multiples of them, and it is a kind of transaction of payment for money, that is, when applying for purchase and redemption, what is paid or recovered is not cash but a portfolio of stocks. The second is to be listed on the exchange and traded in cash.

Unlike the usual open-end funds, exchange-traded funds can be bought and sold throughout the trading day, just like stocks, and short-term arbitrage can also be carried out. Therefore, only institutions or wealthy individuals can apply for purchase and redemption directly from the fund company. For ordinary individual investors, they can only use the second way to buy and sell on the exchange through brokers.

Because most of them are index investments under passive management, exchange-traded funds do not have to bear the expenses of large investments and research teams, so their costs are low, and their management rates are even lower than those of index mutual funds with the lowest fees. For example, SPDRs reduced management fees to 0.12% a year in 2000.

02 index investment + arbitrage mechanism

Most of the passive investment or indexed investment is the characteristic of exchange-traded funds, and most of the indexes they choose are familiar with and widely recognized by investors. In the United States, there are SPDRs close to S & P 500s, Qubes tracking Nasdaq 100s, and so on.

Why do you choose indexed investment? This should first mention the price change law of exchange-traded funds and its arbitrage mechanism.

The market price of exchange-traded funds does not follow the net value of fund units, but depends on the relationship between supply and demand of funds, which is driven by the portfolio value of fund assets. In addition, there are other influencing factors, so the market price of the fund fluctuates around the net value of the unit.

It is also worth noting that large institutions are allowed to apply for purchase or redemption, thus forming an arbitrage mechanism so that the market price of the fund will not deviate too much from the unit net value. For example, when a fund trades at a discount, institutional investors will buy fund units through the secondary market, then redeem them to get a portfolio of stocks, and then sell the shares at a profit.

This carry trade greatly increases the demand for discount-traded funds, thus narrowing the gap between the market price and the unit net worth of the fund. It is precisely because of the existence of the arbitrage mechanism that the market price of the fund is consistent with the unit net value most of the time.

When relying on the arbitrage mechanism to maintain the consistency between the price and net asset value of the fund in the exchange market, arbitrageurs need to obtain comprehensive and timely information about the fund portfolio. Since it is usually impossible for active investment funds to disclose information about their portfolios, passive index investment has become the first choice.