ETFs are passively-managed open-ended funds, unit trust or similar investment arrangement that is listed and/or traded on HKEX. ETFs in Hong Kong are authorized by the Securities and Futures Commission (SFC) of Hong Kong. The principal objective of an ETF is to track or replicate the performance of an underlying index. ETFs trade like stocks. Investors indirectly invest in the portfolio by holding beneficiary categories, which represent the index funds. Therefore, investors are able to follow the trend of the index by investing in the ETF.
Physical ETFs directly buy all the assets needed to replicate the composition and weighting of their benchmarks (e.g. constituents of a stock index). However, some only buy a portion of the assets needed to replicate the benchmarks or assets which have a high degree of correlation with the underlying benchmarks. Some physical ETFs with underlying equity-based indices may also invest partially in futures and options contracts.
Synthetic ETFs do not buy the assets in their benchmark, but invest in financial derivative instruments to replicate the benchmark’s performance. The ETFs are required to have collateral when investing in derivatives. An ETF’s net risk exposure to any single counterparty cannot be more than 10% of its NAV. For details on collateral requirements, please refer to the SFC’s press release.
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ETFs are passively-managed funds. The aim of an ETF is to track the performance of a specified index, and to provide investors with a return close to that index.
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Unlike mutual funds which require the support of a research team for each individual stock, ETF managers only has to passively adjust the constituents in the portfolio by tracking and monitoring the pulse of the market. Furthermore, the transaction cost of ETFs is lower than that of a traditional open-end fund, as expense ratio of an ETF is lower than that of an actively-managed fund. Therefore, the management fee is lower than the typical mutual funds.
Creation: Meaning to create more units for its ETF. A basket of shares represent a unit of ETF. In order to create one unit of ETF, investor needs to buy the shares or pay the amount equivalent to the market value to create a unit of ETF. The Asset Under Management (AUM) of ETF will increase in this case.
Redemption: Meaning to redeem units from ETF. The AUM of ETF will decrease by Investors redeeming a unit of ETF back to a bundle of shares. Investors usually receive the amount equivalent to the market value of the bundle of shares.
Arbitrage: The value of ETF is measured by NAV. NAV might be different from the market price trading in Hong Kong Stock Exchange. Arbitrage exits as a result of a difference in the prices in NAV and market price, where there is the opportunity to trade in discount or premium.