Exchange traded funds are "created" by large investors and institutions in block-sized units of shares (or multiples thereof) known as "Creation Units." A creation requires a deposit with the trustee for a specified number of shares of a portfolio of securities closely approximating the composition of the specific index, and a specific amount of cash in return for shares of a specific exchange traded fund. Similarly, block-sized units of exchange traded fund shares can be redeemed in return for a portfolio of securities approximating the index and a specified amount of cash.
ETFs are investments that track a particular index, a broad sector, or a group of international stocks through a basket of securities. Although they are constructed like mutual funds, ETFs trade like individual securities on stock exchanges. This gives investors the best of both worlds, as they combine the conservative diversity of a mutual fund with the flexibility of a stock. Almost anything that can be done with a stock can be done with an ETF.
ETFs offer investors a variety of benefits including:
- Investors can buy and sell at any time during the trading day
- Investors can instantly get exposure to a portfolio of stocks or bonds
- Investors can buy on margin
- Investors can sell short
- No sales loads, although brokerage commissions will apply
- Lower fees
- Transparency
- Tax efficiencies
Transparency: Know what you own and know its worth.
ETFs are designed to track their benchmarks as closely as possible. Because each HealthShares™ ETF reports the fund’s underlying holdings daily, you always know what you own. Also, just like a stock, HealthShares™ ETFs trade throughout the day and each fund’s underlying holdings are priced continuously.
Flexibility: More possibilities
ETFs offer investors instant exposure to a portfolio of securities that might otherwise be difficult to access. This is particularly true of HealthShares™ because biotech, life science, and healthcare companies are some of the toughest to invest in. HealthShares™ ETFs can also be bought on margin, sold short (even on a downtick), and they allow investors to engage in options strategies.
Lower fees: Costs matter. Why start the race at the back of the pack?
When it comes to performance, controlling costs is a must. HealthShares™ ETFs have an expense ratio of .75% (.95% for our two foreign ETFs). HealthShares™ have lower fees than most actively managed funds, which averaged a 1.3% expense ratio at year-end 2005 (Morningstar).
Tax efficiency*: After-tax return shouldn't be an afterthought.
Just like costs, taxes can have a significant impact on performance. As a mutual fund investor, your tax liability is often out of your hands. Mutual Fund shares are purchased and redeemed from the fund itself, so when fund managers need cash to pay for redemptions, a capital gain may be incurred. Regardless of whether you sold your shares, part of the capital gain will be your responsibility.
When buying and selling an ETF, traditional brokerage commissions apply, but because of the unique creation/redemption process with ETFs, owners have greater control over their tax liability. Rather than purchasing directly from the fund, you buy shares from other investors on an exchange. So while there are some instances in which you may be responsible for capital gains distributions, this is generally not the case unless, of course, you are selling an investment that has appreciated.*
*As with any open-ended fund, HealthShares™, ETFs may realize gains due to index rebalancing or diversification requirements and are obliged to distribute portfolio gains to shareholders by year-end. Trading shares of the HealthShares™ Funds will also generate tax consequences and transaction expenses. Certain traditional mutual funds can be tax efficient as well.
Although XShares Advisors LLC believes that market makers will take advantage of differences between the NAV and the trading price of HealthShares™, ETF shares through arbitrage opportunities, XShares Advisors cannot guarantee that they will do so.