Unique Risks of ETFs in Passive Equity Investing

Very Hard Passive Equity Investing Exchange-traded Funds

In a recent analysis of exchange-traded funds (ETFs), a leading investment firm assessed the advantages and disadvantages of using ETFs compared to traditional mutual funds for passive equity investing. The firm noted that while passive ETFs offer lower expense ratios and greater tax efficiency due to their unique creation and redemption mechanism, there are specific scenarios in which ETFs might underperform relative to expectations.

Given this context, which of the following statements accurately captures one of the unique risks associated with investing in ETFs?

ETFs can trade at a significant premium or discount to their net asset value (NAV), especially in periods of market volatility.

ETFs are guaranteed to track the performance of an index without any risk of deviation.

ETFs incur operational risk through complex tax structures that are not present in mutual funds.

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