ETF investing lexicon: a glossary of essential terms

This concise glossary provides Saxo Bank clients with clear definitions of key ETF terminology for quick reference when researching, selecting, and managing exchange-traded fund investments.

A–C

Accumulating ETF: An ETF that automatically reinvests dividends and interest back into the fund rather than distributing them to shareholders, potentially enhancing compounding effects.

Active ETF: An ETF where portfolio managers actively select investments rather than passively tracking an index, typically charging higher fees in pursuit of outperformance.

Assets under management (AUM): The total market value of assets an ETF controls, often used as an indicator of the fund's size, stability, and liquidity.

Authorized participant (AP): Financial institutions that create and redeem ETF shares directly with the fund provider, playing a crucial role in ETF liquidity and pricing efficiency.

Bid-ask spread: The difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask) for an ETF, representing an implicit cost of trading.

Counterparty risk: The possibility that the other party in a financial transaction might default on their contractual obligation, particularly relevant for synthetic ETFs using swap agreements.

Creation/redemption mechanism: The process by which ETF shares are created or redeemed in large blocks called creation units, typically involving authorized participants exchanging a basket of securities for ETF shares or vice versa.

D–I

Distributing ETF: An ETF that pays out dividends and interest directly to shareholders rather than reinvesting them, suitable for investors seeking regular income.

Domicile: The country where an ETF is legally established, which affects its regulatory framework, tax treatment, and reporting requirements.

Expense ratio: The annual fee charged by an ETF to cover operating costs, expressed as a percentage of assets and directly reducing investor returns.

ETF provider: The financial institution that creates, manages, and markets ETFs, such as BlackRock (iShares), Vanguard, or State Street (SPDR).

Equal-weight index: An index methodology that assigns the same weight to each constituent regardless of size, contrasting with market-cap weighting.

ISIN (international securities identification number): A 12-character alphanumeric code uniquely identifying an ETF for trading and settlement purposes.

Index: A statistical measure of a market or market segment used as a benchmark for ETF performance, such as the S&P 500 or MSCI World.

K–P

Key information document (KID): A standardized disclosure document required in Europe that provides essential information about an ETF's objectives, risks, costs, and potential returns.

Leveraged ETF: An ETF designed to deliver multiples (e.g. 2x or 3x) of the daily return of an underlying index using derivatives and debt.

Liquidity: The ease with which an ETF can be bought or sold without significantly affecting its price, typically measured by trading volume and bid-ask spreads.

Market maker: A firm that provides liquidity by continuously offering to buy and sell an ETF, helping to maintain orderly trading and tight bid-ask spreads.

Net asset value (NAV): The per-share value of an ETF's underlying assets minus liabilities, calculated at the end of each trading day.

Passive ETF: An ETF that aims to replicate the performance of a specific index by holding the same securities in the same proportions, typically charging lower fees than active ETFs.

Premium/discount: The difference between an ETF's market price and its NAV, expressed as a percentage. A premium occurs when the market price exceeds NAV; a discount occurs when the market price is below NAV.

R–Z

Rebalancing: The process of adjusting an ETF's holdings to maintain alignment with its target index or strategy, typically occurring quarterly or annually.

REIT ETF: An ETF that invests in real estate investment trusts, providing exposure to real estate markets without direct property ownership.

Sector ETF: An ETF focused on companies within a specific industry sector, such as technology, healthcare, or energy.

Smart beta ETF: An ETF that uses alternative index construction rules rather than traditional market capitalization weighting, often focusing on factors like value, momentum, or low volatility.

Swap: A derivative contract used by synthetic ETFs where counterparties exchange cash flows, with one party providing the exact return of the index the ETF tracks.

Synthetic ETF: An ETF that uses derivatives like swaps rather than directly holding the underlying assets to track an index's performance.

Tracking difference: The actual difference between an ETF's return and its benchmark index's return over a specific period, reflecting the impact of fees, trading costs, and other factors.

Tracking error: A measure of how consistently an ETF follows its benchmark, calculated as the standard deviation of the difference between the ETF's returns and the index's returns.

UCITS (undertakings for collective investment in transferable securities): A regulatory framework for investment funds in Europe, setting standards for investor protection and fund structure.

Volatility: A statistical measure of the dispersion of returns for an ETF, indicating the degree of variation and risk.

Yield: The income returned on an ETF, typically expressed as a percentage based on dividends or interest payments relative to the ETF's price.

This glossary serves as a quick reference guide for Saxo Bank clients navigating the ETF landscape. For more detailed explanations of these concepts, refer to the previous articles in this series.