While exchange traded funds are registered with the Securities and Exchange Commission as investment companies - either as an open-end fund or a unit investment trust - they differ from traditional mutual funds both in how their shares are issued and redeemed, and in how their shares or units are traded. Unlike traditional mutual funds or unit investment trusts, ETF shares are created by an institutional investor depositing a specified block of securities with the ETF. In return for this deposit, the institutional investor receives a fixed amount of ETF shares, some or all of which may then be sold on a stock exchange. The institutional investor may obtain its deposited securities by redeeming the same number of ETF shares it received from the ETF. Retail investors can only buy and sell the ETF shares once they are listed on an exchange, much as they can buy or sell any listed equity security. Unlike an institutional investor, a retail investor cannot purchase or redeem shares directly from the ETF as with a traditional mutual fund or unit investment trust.
Just like an index mutual fund, when you buy an ETF you are buying shares in a portfolio of dozens - if not hundreds - of stocks (or bonds). This basket of stocks is tied to an underlying index, meaning it holds the same stocks as an index. Two of the most popular ETFs are the SPDR (symbol: SPY), which tracks the performance of the S&P 500 stock index, and the NASDAQ 100 Trust Series (symbol: QQQ), which tracks the performance of the NASDAQ 100 stock index.
There are important differences between ETFs and traditional mutual funds. The table below provides a quick understanding of the distinctions between an ETF and a Mutual Fund, which can help you to be a more successful investor.
| ETFs | Traditional Retail Mutual Funds |
|---|---|
| Priced and traded continuously throughout the day. | Typically, only priced and traded at NAV and the end of the trading day. |
| In-Kind creation/redemption process can reduce tax liabilities of shareholders. | Net redemptions can create taxable distributions for non-redeeming shareholders. |
| Investors buy and sell shares on an exchange. Because this does not affect the underlying portfolio, the likelihood of tax consequences is reduced for other shareholders. | Individual redemptions with the fund may result in a capital gains tax distribution for non-redeeming shareholders. |
| Like stocks, can be traded with limit orders, stop limits, and can be sold short. | Limit order pricing, and short selling not available. Transactions typically completed at NAV at the end of the trading day. |
| Can be bought and sold on margin. | Funds cannot be bought and sold on margin |
| Offer low to moderate expense ratios; domestic funds' ratios are lower than international funds' ratios. | Offer low to moderate expense ratios depending on fund; domestic fund ratios tend to be lower than international fund ratios |
| Can be bought and sold through any brokerage account. | Availability through brokers depends on negotiated selling agreements. Not all funds are available through brokerage firms and must be purchased from the fund company. |
| Normal brokerage account commissions apply. | Funds usually charge a sales load. No-load funds often have transaction charges. |
There are special risks associated with margin investing. As with stocks, you may be called upon to deposit additional cash or securities if your account equity including that which is attributable to HealthShares Funds, declines. With short sales, you risk paying more for a security than you received from its sale.
Transactions in shares of the HealthShares Funds will result in brokerage commissions and will generate tax consequences. Mutual funds and HealthShares are obliged to distribute portfolio gains to shareholders.
Shares of the HealthShares Funds may be sold throughout the day on the exchange through any brokerage account. However, shares may only be redeemed directly from the fund by Authorized Participants in 100 share creation/redemption units.
Neither HealthShares Inc nor its advisor, XShares Advisors provides tax advice. Please note that (i) any discussion of U.S. tax matters contained in this communication (including any attachments) cannot be used by you for the purpose of avoiding tax penalties; (ii) this communication was written to support the promotion or marketing of the matters addressed herein: and (iii) you should seek advice based on your particular circumstances from an independent tax advisor