Learn how exchange-traded funds work, how ETFs differ from traditional and closed-end funds, their main benefits and risks, key 2025 market trends, and practical considerations for new investors choosing products.
Exchange-Traded Funds: Investment Tools Combining the Features of Shares and Funds
An exchange-traded fund, commonly known as anETF, is a fund listed on a securities exchange that can be bought and sold in the same way as a share. It pools capital from multiple investors and invests proportionately in a basket of assets represented by a particular index, such as equities or bonds, thereby providing diversification. ETFs generally aim to track a specific index, and their portfolios contain the index’s constituent securities, helping to reduce the volatility risk associated with individual shares.
Compared with traditional open-ended funds, ETFs are distinctive because they combine the characteristics of two types of investment instrument. They offer the diversification benefits of a fund while retaining the flexible trading features of shares. Common underlying benchmarks include China’s CSI 300 Index, Hong Kong’s Hang Seng Index and the US Nasdaq-100 Index.
How ETFs Work
When investors purchase an ETF, they do not directly own every constituent security within the underlying index. Instead, they acquire units issued by the fund provider, representing an investment portfolio that holds the basket of assets covered by the index. As ETFs are listed on securities exchanges, investors can trade their units in the same way as listed shares.
An ETF’s ability to trade close to its underlying value depends on a distinctive creation and redemption mechanism. When a significant difference develops between the ETF’s market price and its net asset value (NAV), arbitrage activity can help move the price back towards a reasonable range. The net asset value calculation can be expressed as follows:
Net asset value per unit = (Total fund assets − Total fund liabilities) ÷ Total fund units
How Do ETFs Differ from Similar Investment Products? A Comparison of Core Concepts
Various collective investment products are available in the market. Although their names and structures may appear similar, they have important differences. To clarify how ETFs compare with other commonly used products, the table below provides a conceptual comparison and helps investors avoid confusion when making a selection.
| Comparison Item | ETF | Traditional Open-Ended Fund | Closed-End Fund |
|---|---|---|---|
| Trading Venue | Securities exchange | Fund provider or distributor | Securities exchange |
| Pricing Method | Real-time intraday market price | Net asset value calculated once daily | Real-time intraday market price |
| Management Approach | Mostly passive index tracking | Mostly actively managed | Active or passive |
| Portfolio Transparency | Usually disclosed daily | Disclosed periodically | Disclosed periodically |
As the table shows, the combination of real-time intraday trading and high transparency is a principal strength of ETFs and a key feature distinguishing them from traditional funds.
What Are the Main Advantages of ETFs? Five Core Features Explained
The principal advantages of ETFs include low costs, high transparency, strong liquidity and risk diversification. In certain markets, they may also offer tax efficiencies. These features have made ETFs commonly used instruments for constructing diversified investment portfolios.
Low Costs and High Transparency
Most ETFs are passively managed funds whose objective is simply to track a particular index, rather than frequently adjusting their portfolios in an attempt to outperform the market, as actively managed funds may do. As they require less extensive research and less frequent trading, their management costs are generally lower, resulting in fees that are often significantly below those charged by active funds. For example, an investment of 10,000 yuan in an ETF with an annual management fee of 0.2% would incur a yearly cost of 20 yuan. An actively managed fund charging 1% would cost 100 yuan per year. Over the long term, this difference can become substantial.
In terms of transparency, ETF portfolios are generally disclosed each day, allowing investors to identify the assets held by the fund and their respective weightings. This level of transparency makes it easier to understand how capital is allocated and helps investors assess their risk exposure more accurately.
Liquidity, Risk Diversification and Tax Advantages
ETFs are listed on securities exchanges and can be bought or sold at market prices throughout the trading session, with prices determined by supply and demand. This gives them significantly greater flexibility than traditional funds, which generally process subscriptions and redemptions only once per day at their calculated net asset value. ETFs also hold multiple assets in proportions determined by an index, limiting the effect that volatility in a single security can have on the overall portfolio. In certain markets, including the United States, the ETF creation and redemption mechanism may reduce taxable events caused by frequent sales of portfolio securities, potentially allowing taxes to be deferred or reducing capital gains tax liabilities. Tax rules vary between jurisdictions, however, and investors should refer to the applicable local legislation.
What Risks Should Investors Consider When Investing in ETFs?
Although ETFs offer numerous advantages, investors should still consider several important factors before buying or selling them to avoid unnecessary losses or incorrect assumptions. The main considerations include:
Tracking error: An ETF aims to replicate the performance of an index, but its actual return may differ slightly from that of the benchmark. If an index rises by 10%, for example, the ETF may gain 9.8% or 10.2%. Causes can include transaction costs, cash holdings, management fees and changes to index constituents.
Liquidity and bid-ask spreads: An ETF with limited liquidity may have a relatively wide difference between its buying and selling prices. When trading volume is low, transaction costs may increase accordingly. Selecting larger and more actively traded products can help reduce this risk.
Market risk: Although ETFs diversify the risk associated with individual assets, they cannot eliminate systematic market risk. When the overall market declines, an ETF holding dozens of shares may still incur losses.
Hidden costs: In addition to management fees, brokerage charges, bid-ask spreads and internal portfolio rebalancing costs can affect the investor’s actual net return and should be included in any assessment.
Index selection and fund provider credibility: An ETF’s performance depends entirely on the index it tracks. If the underlying index is highly volatile, the ETF’s risk will rise accordingly. The operational capabilities and disclosure standards of the issuer can also affect the product’s overall reliability.
What New Trends Emerged in the ETF Market in 2025?
The global ETF market has continued to expand rapidly in recent years, setting several records in 2025 and providing important reference points for investors in China and the wider Asia-Pacific region.
Record Market Size and Capital Inflows
According to data from industry research firm ETFGI, assets under management in the global ETF industry reached approximately US$19.85 trillion by the end of 2025, representing growth of about 33.7% from US$14.85 trillion at the end of 2024. Total net inflows reached a record US$2.37 trillion during 2025, exceeding the US$1.88 trillion recorded in 2024. By year-end, approximately 15,807 ETF products were listed across 83 exchanges in 65 countries.(Source: ETFGI, published: 2026-01)
Expansion on this scale has several implications. Investors have access to an increasingly broad selection of instruments, while stronger competition is placing further downward pressure on product fees. Although the entry threshold for beginners is becoming lower, the growing number of products also makes selection more complex.
Product Innovation and the Rapid Growth of Active ETFs
A notable trend in 2025 was that the market was no longer limited to traditional index-tracking ETFs. More specialised products, including thematic, sector and actively managed ETFs, expanded rapidly. Active ETFs performed particularly strongly, with their global assets increasing by approximately 59% during 2025, from about US$1.17 trillion at the end of 2024 to approximately US$1.86 trillion by year-end. For traders, this provides access to particular themes such as technology, consumption and growth, although these products may be more volatile and more dependent on prevailing market trends.
China Becomes a Major Focus
Within the Asia-Pacific region, China’s ETF market delivered particularly strong growth. Supported by a recovery in the A-share market, the total size of China’s ETF sector passed several trillion-yuan milestones during 2025 and, at one point, surpassed Japan to become Asia’s largest ETF market. Products tracking the CSI 300 Index continued to rank among the largest by assets.(Source: Morningstar, published: 2025-08)
However, several structural factors require attention as the Chinese market expands rapidly. Policy adjustments, regulatory changes and geopolitical developments remain important influences on market direction. Certain specialised products may also face limited liquidity or relatively high tracking errors.
How Should New Investors Get Started? Practical Guidance
For investors approaching ETFs for the first time, establishing a clear investment framework is particularly important. The following steps may serve as an introductory reference, but they do not constitute investment advice. Any decision should be assessed carefully in light of the investor’s individual circumstances:
Open a securities account and understand the basic rules of the intended ETF, including its trading hours, transaction fees and minimum trading unit.
At the initial stage, consider products that track broad market indices, charge relatively low fees and have high trading activity.
Define the purpose of the transaction and distinguish between medium-term holding and short-term trading, as each objective requires different selection criteria.
Control the amount of capital invested and the size of each position, avoiding excessive concentration in a single product or market.
Review the investment regularly and continue monitoring the ETF’s performance, fee changes and evolving market conditions.
Building on this foundation, maintaining a habit of continuous learning and developing a deeper understanding of ETF market mechanisms, index composition and economic policy changes may help investors make more rational decisions during volatile market conditions. ETFs provide a convenient means of constructing diversified portfolios through their low costs, high transparency and risk-spreading characteristics. Nevertheless, understanding how they work, allocating capital appropriately and applying disciplined risk management remain essential prerequisites for market participation.
Frequently Asked Questions About ETFs
What is the main difference between an ETF and a traditional open-ended fund?
The principal differences relate to trading and pricing. An ETF is listed on a securities exchange and can be bought or sold at real-time market prices throughout the trading session. A traditional open-ended fund generally processes subscriptions and redemptions only once per day at its calculated net asset value. In addition, most ETFs passively track an index and disclose their holdings daily, providing relatively greater transparency.
What is an ETF tracking error?
Tracking error is the difference between an ETF’s actual return and the performance of the index it follows. For example, if an index rises by 10%, the ETF may gain only 9.8% or may increase by 10.2%. Possible causes include transaction costs, management fees, cash holdings and adjustments to index constituents.
How does the ETF creation and redemption mechanism work?
The mechanism is designed to keep an ETF’s market price close to its net asset value. When the difference between the market price and net asset value becomes too large, designated institutional participants can conduct arbitrage through the creation or redemption of ETF units. This process helps move the price back towards a reasonable range and supports efficient ETF pricing.
How large was the global ETF market in 2025?
According to ETFGI, assets under management in the global ETF industry reached approximately US$19.85 trillion by the end of 2025, an increase of about 33.7% from the end of 2024. Annual net inflows totalled approximately US$2.37 trillion, with both figures reaching record highs.
How should a beginner choose a first ETF?
Beginners may initially consider larger and more actively traded ETFs that track broad market indices and charge relatively low fees. These products generally provide stronger liquidity and more consistent index tracking. The final selection should also reflect the investor’s objectives and tolerance for risk.
