Exchange-traded funds—commonly referred to as ETFs—are investment instruments that allow investors to buy and sell units like stocks. They are collections of securities, such as stocks, bonds, or commodities, and typically represent a diversified investment in a particular market or industry.
The main difference between creating and redeeming ETFs is that there are no brokerage fees, as they are essentially being made from a pool of other investors’ contributions. In contrast, when redeeming ETFs, there may be a redemption fee levied by your chosen broker.
Advantages of ETFs
ETFs trade on exchanges and can be bought and sold just like individual stocks. They offer investors several advantages, including:
Broad diversification
ETFs offer exposure to a wide range of domestic and international assets.
Liquidity
You can buy and sell ETFs at any time during the trading day.
Fees
ETFs typically have lower fees than mutual funds.
Tax efficiency
ETFs are often more tax-efficient than mutual funds.
How to create an ETF
To create an ETF, you will need to have a brokerage account with a stockbroker that offers ETF creation facilities. You will also need to identify the ETF you wish to create and the amount you want to invest.
The process of creating an ETF is relatively simple. First, you will need to identify the ETF you want to buy and the number of units you wish to purchase. You can then enter these details into the online order form on your brokers’ websites. Once the order has been submitted, the shares will be created and allocated to your account.
How to redeem an ETF
Redeeming ETFs is very similar to redeeming regular stocks or unit trusts. First, you will need to identify which stockbroker you want to use for redemption. Then, follow their instructions on how to place a redemption order online with them. The number of units redeemed will usually be sent to you within three days if it is not automatically placed into your designated bank account.
The risks of creating and redeeming ETFs
Traders should consider the risks of creating and redeeming ETF units before investing. There are different types of risks to consider, ranging from liquidity to counterparty risk.
Liquidity
There is a lack of depth in the Singapore market which means ETF units may not be created in large quantities when demand for them increases suddenly. This creates temporary illiquidity that can be especially dangerous in periods where markets are falling rapidly, leading to losses that would otherwise not have occurred if there had been ample liquidity beforehand.
On the other hand, illiquidity can also present opportunities to traders who are aware of it and want to use it by buying units when they are cheap and selling them when prices rise again. While this is possible, it requires a significant amount of research or knowledge to take advantage of.
Counterparty risk
ETFs offer little protection from counterparty risk, where the ETF issuer goes bankrupt and cannot provide investors with their money. This can be a severe problem when investing in less established ETFs that do not have a strong track record in providing returns for their investors.
To conclude
ETFs are popular investment options in Singapore due to the wide range of benefits they offer investors. Creating an ETF is simple – all you need to do is identify which fund you would like to buy and how many units you want, and then submit an online order form. Redeeming ETFs is just as easy – all you need to do is find a stockbroker that offers redemption facilities and follow their instructions.
So, if you’re interested in ETF trading, be sure to familiarise yourself with the creation and redemption process. New traders are advised to use a reputable online broker from Saxo Bank and trade on a demo account before real money.
