PIMCO ETFs - Education - ETF Basics

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What is an Exchange-Traded Fund? 

One of the fastest growing investment vehicles over the past decade, an exchange-traded fund (ETF) is a fund that issues shares that trade throughout the day on an exchange and represent an investment in a portfolio of securities or assets. Shareholders in an ETF, like those in a mutual fund, are exposed to potential gains or losses in the underlying assets.

ETFs have become popular for several reasons. Because they are sold on open exchanges, such as the New York Stock Exchange or NASDAQ, they are priced throughout the day and can be traded much like stocks. Investors in ETFs can sell short, buy on margin, and use limit orders, stop-loss orders and, in many cases, options. Mutual funds, by contrast, are priced at the end of the trading day at their Net Asset Value or “NAV” as opposed to a market clearing share price. In addition, ETFs may be more tax efficient than mutual funds. While expense ratios for ETFs may be comparable with expense ratios of like-strategy, mutual fund institutional share classes, ETF purchases normally involve trading commissions and a bid/ask spread. The risks in ETFs mainly mirror those in the underlying securities, including market risk, and in the case of bond ETFs, credit and interest-rate risk. (See related article for more on the benefits of ETFs .)

The main difference between ETFs and mutual funds is how they are structured. Mutual funds issue shares in the fund directly to investors that can be redeemed directly back to the fund at a value determined at the end of each trading day (the Net Asset Value, or NAV). To create shares of an ETF, the ETF issues shares of the fund in large blocks to “authorized participants” – usually large investment banks who have signed an agreement with the fund – in return for a basket of the underlying securities and/or cash. Authorized participants then typically sell the shares in the market at the prevailing market price operating as a market maker in the ETF.

The first U.S. ETF was launched in 1993 when State Street Global Advisors launched ‘SPY' to track the S&P 500 index as the first in a series of SPDR funds, or “Spiders”. Since then, ETFs have grown quickly, with over 750 funds in the U.S. totaling more than $535 billion as of April 2009, according to the latest data compiled by the National Stock Exchange.

While stock market index funds represent the bulk of existing ETFs, there are now many different types of indexes in these funds, including bond, commodity, currency, sector- and country-specific, and even leveraged and inverse funds. Actively-managed ETFs were also approved by the SEC in early 2008. These funds contrast with index funds in that a portfolio manager actively manages the securities owned by the fund, typically with an objective of providing above-benchmark returns.

ETFs allow investors to fill gaps in their portfolios, much like mutual funds can – but often with greater trading flexibility. Similar to mutual funds, investors can use ETFs to take positions on specific sectors or countries or assets without purchasing the underlying securities directly. Among other strategies, bond ETFs may offer exposure to broad indexes, specific segments of the bond market and specific components of yield curves.

Investors should consider the investment objectives, risks, charges and expenses of the funds carefully before investing. This and other information are contained in the fund’s prospectus, which may be obtained by contacting your PIMCO representative or by clicking HERE. Please read the prospectus carefully before you invest or send money.

Exchange Traded Funds (“ETF”) are afforded certain exemptions from the Investment Company Act. The exemptions allow, among other things, for individual shares to trade on the secondary market. Individual shares cannot be directly purchased from or redeemed by the fund. Purchases and redemptions directly with ETFs are only accomplished through creation unit aggregations or “baskets” of shares. An investment in an ETF involves risk, including the loss of principal. Investment return, price, yield, and NAV will fluctuate with changes in market conditions. Investment policies, management fees and other information can be found in the individual ETF’s prospectus.

Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk; investments may be worth more or less than the original cost when redeemed. Derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested.

ETFs are subject to secondary market trading risks. Shares of the Fund will be listed for trading on an exchange, however, there can be no guarantee that an active trading market for such shares will develop or continue. There can be no guarantee that the Fund’s exchange listing or ability to trade its shares will continue or remain unchanged. Shares of the Fund may trade on an exchange at prices at, above or below their most recent NAV. The per share NAV of the Fund is calculated at the end of each business day, and fluctuates with changes in the market value of the Fund’s holdings. The trading prices of the Fund’s shares fluctuate continuously throughout the trading day based on market supply and demand, which may not correlate to NAV. The trading prices of the Fund’s shares may differ significantly from NAV during periods of market volatility, which may, among other factors, lead to the Fund’s shares trading at a premium or discount to NAV.

Buying or selling ETF shares on an exchange may require the payment of brokerage commissions. Due to the costs inherent in buying or selling Fund shares, frequent trading may detract significantly from investment returns. Investment in Fund shares may not be advisable for investors who expect to engage in frequent trading.