An ETF (exchange-traded fund) is a security that holds assets such as stocks, bonds, etc and is traded on a stock exchange.
Most ETFs are passively managed and track an index (such as S&P 500 or DJIA). The manager of the ETF will buy the stocks that make up the index and then issue out their ETF units (or shares) that represent ownership of the underlying stocks. These units are then traded on the stock exchange.
To ensure liquidity for retail investors, it is important for creators of ETFs to be market makers (or appoint one) to cater for the trading of these units.
Large institutional investors can create or redeem their units with the ETF manager directly. This creates arbitrage opportunities whenever there is a gap between the traded price of the ETF and its NAV. Therefore, most ETFs should trade at close to their NAV in normal circumstances.
For example, if the NAV of STI ETF is 1500 but it is only trading at 1400, someone can buy up the units on the market and then redeem them with the ETF manager for 1500.
Since there is very little fund management involved in passively managed ETFs, their annual fees can be as low as 0.1% p.a. As such, ETFs might be attractive to investors who would like to create a diversified portfolio that is more cost efficient than other collective investment schemes like unit trusts.
The argument for ETFs is that most fund managers underperform the market anyway, so investors are better off to just invest in low cost and passively managed investments.
Another argument is that your commission charges (<1%) are lower when you buy ETFs compared to the 2-5% bid-offer spread for unit trusts. While this might be true, note that when you buy ETFs on the secondary market, there is also a bid-offer spread involved. The spreads of the bid and offer price will depend on a few factors, one of which is the liquidity of the underlying assets making up the ETF.
Most people will associate ETFs with low cost (annual management fee). However, note that in recent years, we also see the emergence of actively managed ETFs. These are essentially actively managed funds (just like unit trusts) operating under the structure of an ETF. The fees of such ETFs would definitely be higher than the normal index tracking ETFs and might not differ much from their unit trust counterparts.
As ETFs become more popular with the investing public, we should see more of them coming to our local market. Thousands of ETFs (catering to just about every asset class you can think of) are listed in more developed markets like the US and Europe. Currently, there are 29 ETFs listed on the SGX. 5 of them are cross-listed in the US but have zero trading activity here due to the absence of a market maker.