How ETFs Work on Bursa Malaysia: Structure and Mechanics
The short answer
An exchange-traded fund (ETF) is an index-tracking fund that is listed and traded on a stock exchange like a share [1]. In Malaysia it is structured as a unit trust, and its units are created and redeemed in bulk by institutional parties known as participating dealers [1][2]. Market makers help keep trading orderly, while tracking error shows how closely the fund follows its index [1][3].
What is an ETF?
An ETF is an open-ended investment fund that tracks a particular index, is passively managed and is traded on the exchange in the same manner as a stock [2]. InvestSmart describes it in similar terms: index-tracking funds that are listed and traded like stocks [1].
In Malaysia an ETF is structured as a unit trust while also being tradable on Bursa Malaysia during the usual trading hours [1]. It must comply with the relevant SC requirements, and the SC notes that its authorisation does not imply endorsement of any particular product [1].
The index can be a local one such as the FBM KLCI or a bond index [1]. You can learn about the benchmark in our entry on the FBM KLCI. An ETF may or may not distribute dividends, depending on its dividend policy [1].
How are ETF units created and redeemed?
Units are created and redeemed in bulk by institutional investors, not by ordinary buyers on the exchange. According to the SC, an ETF as an open-ended fund can have units continuously created and redeemed by institutional investors, which supplies liquidity to balance supply and demand [2].
The SC’s ETF Guidelines provide for participating dealers, who are essentially stockbroking companies or financial institutions appointed by the management company as the intermediary for creation and redemption, and who may also act as market makers [2].
In simple steps:
- A participating dealer delivers the basket of securities that the fund tracks, or cash, to the manager.
- The manager issues new ETF units in return, which the dealer can then sell on the exchange.
- For redemption, the process runs in reverse: units go back and the basket comes out.
Because this route exists, the SC explains that investors can arbitrage discounts and premiums that arise between the ETF price and its net asset value (NAV) [2]. The exact baskets and unit sizes differ by fund, so read the prospectus.
What does a market maker do?
A market maker stands ready to quote prices at which it will buy and sell, so that a buyer does not have to wait for a matching seller. A Malaysian ETF manager’s explainer describes market makers as creating liquidity by being ready to execute trades at publicly quoted prices [3].
Bursa Malaysia announced a market making framework for ETFs and structured warrants in 2009, intended to provide a regularised platform for market makers and to improve liquidity and efficiency [4]. Eligible corporations can be admitted as market makers by registering with Bursa Malaysia [4].
A market maker does not guarantee a price or a profit for you. It narrows the gap between buying and selling quotes in normal conditions, which can widen when markets are stressed.
What are NAV, iNAV and tracking error?
NAV is the value of the fund’s holdings per unit. InvestSmart explains that each ETF has a NAV calculated with reference to the market value of its securities, while the trading price is set by supply and demand and may not equal the NAV [1].
Some ETFs also publish an indicative NAV during the trading day, often shortened to iNAV, which estimates what the units are worth as the holdings move. Check the manager’s documents to see whether one is provided and how it is calculated.
Tracking error is the difference between the performance of the ETF, measured by its NAV, and the performance of the index it follows [1]. A fund may not hold every constituent in the same weights as the index, so it can do better or worse than the index [1].
What types of ETF exist and what do they cost?
ETFs differ mainly by what they track. InvestSmart’s examples include equity indices such as the KLCI and bond indices [1]. Some track Shariah-screened indices. The FBM EMAS Shariah Index, for example, uses the SC’s Shariah-compliant list as its basis [5], so an ETF built on it would inherit that list’s reviews.
There are two layers of cost. Management fees and other administrative costs are usually deducted from the fund’s assets and so affect NAV, while trading an ETF on Bursa Malaysia also incurs brokerage fees, stamp duty and similar transaction costs [1].
An ETF trades in board lots, and InvestSmart notes that these are usually kept at an affordable level [1]. See our entry on the board lot for the basics. ETFs still carry market risk, since they are exposed to the risks of the market or sector they track [1]. Our guide to stock market risk management and the page for beginners cover next steps.
Frequently asked questions
What is an ETF?
An index-tracking fund that is listed and traded on a stock exchange like a share [1].
What is tracking error?
It is the difference between the ETF’s NAV performance and the performance of the index it follows [1].
What does a market maker do?
It stands ready to buy and sell at publicly quoted prices, which supports liquidity [3].
What costs apply to an ETF?
Management fees and administrative costs are deducted from fund assets, and trading adds brokerage fees, stamp duty and similar charges [1].
Sources
- InvestSmart (Securities Commission Malaysia) — ETF features, unit trust structure, NAV versus trading price, fees, tracking error, risks, board lots
- Securities Commission Malaysia — media release on ETF Guidelines: open-ended index fund, continuous creation and redemption, participating dealers, arbitrage between price and NAV
- Eq8 Capital — ETF ecosystem: participating dealers and market makers described by a Malaysian ETF manager
- Mondo Visione (Bursa Malaysia announcement, 2009) — market making framework for ETFs and structured warrants
- Securities Commission Malaysia — media release noting that the FBM EMAS Shariah Index uses the SC Shariah-compliant list as its basis
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