Frequently Asked Questions About Exchange-Traded Funds

What is an exchange-traded fund?
An exchange-traded fund (ETF) is an investment company with shares that trade intraday on stock exchanges at market-determined prices. Investors may buy or sell ETF shares through a broker or in a brokerage account, just as they would the shares of any publicly traded company.

What are the structural differences between ETFs and mutual funds?
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.

What are ETF assets relative to mutual fund assets?
At year-end 2006, overall ETF assets totaled $422.55 billion, compared to $10.4 trillion in mutual funds.

ETF Assets
(billions of dollars, year-end)

How many ETFs are available to investors?
As of year-end 2006, 359 exchange-traded funds were available to investors, compared with 80 funds at year-end 2000.

How long have ETFs been available to investors?
The first exchange-traded fund, an S&P 500-index fund, began trading on the American Stock Exchange in January 1993. A second ETF tracking the S&P MidCap 400 index was added in 1995 and 17 ETFs linked to international stock exchanges began trading in 1996.

What is in the portfolio of domestic ETFs?
Most of the ETFs trading on U.S. stock exchanges today are equity index funds. As of year-end 2006, 252 tracked domestic stock indexes and had assets of $276.14 billion. Six funds tracked bond indexes and held $20.5 billion in assets. Among domestic ETFs, 133 used broad indexes and 135 funds targeted sector or industry groups. Broad-based domestic ETFs were the larger of the two domestic groups with $232.49 billion in assets. Domestic sector or industry ETFs had assets of $58.36 billion.

Do ETFs track international indexes?
Yes. As of year-end 2006, 85 ETFs tracked global/international stock indexes. Most of the global/international ETFs are either country-specific or regional index funds; however, 17 ETFs track global index funds. Altogether, global/international ETFs held $111.19 billion in assets as of year-end 2006.

How are ETFs regulated?
The vast majority of exchange-traded funds are registered with the Securities and Exchange Commission (SEC) and must comply with the applicable provisions of the Investment Company Act, except to the extent the fund or trust has received exemptive relief from the Act. Exchange-traded funds have obtained exemptive relief to (1) allow them to register as mutual funds under the Act even though their shares are not individually redeemable (ETFs are, however, prohibited from referring to themselves as mutual funds.); (2) permit affiliated entities to purchase and redeem shares in kind rather than in cash; and (3) enable their shares to trade at negotiated prices on an exchange rather than at a current offering price described in the prospectus or at a price based on net asset value (NAV).

As of 2006, about 3 percent of ETF assets were not registered with or regulated by the SEC under the Investment Company Act. These ETFs are commodity-based. Those ETFs that invest in commodity futures are regulated by the Commodity Futures Trading Commission (CFTC), while the ETFs that invest solely in physical commodities are not regulated by the CFTC.

What is included in ICI's monthly ETF report?
The Institute's monthly statistical collection includes the combined assets of the nation's exchange-traded funds (equity and bond ETFs), and the value of shares issued and redeemed. All ETFs registered as investment companies with the SEC as well as non-registered ETFs are included in the statistical release. However, trust-issued receipts, such as Holding Company Depository Receipts (HOLDRS), are not included in the report. Statistics contained in the report have been obtained from information provided to ICI by exchange-traded funds.

June 2007