Exchange-Traded Funds

WHAT ARE EXCHANGE-TRADED FUNDS?
Exchange-traded funds (ETFs) are index-based investment products that combine key elements of mutual funds, such as diversification, with those of stocks, such as access to intraday trading and leveraging strategies.

WHEN SHOULD YOU CONSIDER EXCHANGE-TRADED FUNDS?
If you're seeking a cost-effective, tax-efficient and convenient way to obtain portfolio diversification and also want the flexibility to employ strategies designed to enhance total return, consider ETFs.

WHAT ARE THE BENEFITS OF EXCHANGE-TRADED FUNDS?

Diversify your portfolio easily and cost effectively

• Through a single, cost-effective transaction, you can obtain diversified equity exposure that tracks the performance of a specific index, industry, geographic region or investment style.
  
  
• ETFs track the performance of more than 100 individual stock market indexes, including well-known benchmarks such as the Dow Jones Industrial Average, the Standard & Poor's 500 Index and the Nasdaq-100, and specialized indexes like the Russell 2000 Index of small-cap stocks.
  
  
• You can invest in companies within a favored sector. ETFs track a variety of sectors, including financial services, health care, semiconductors, real estate and technology.
  
  
• ETFs allow you to participate in the performance of stocks in dozens of developed and developing nations — as well as global regions such as Europe and Asia — through trading during U.S. hours, either regionally or on a sector basis.¹
  
  
• You can balance your portfolio with fixed-income exposure by purchasing ETFs that track the performance of a "basket" of bonds (for example, corporate, government and diversified bonds).
  
  
• With ETFs, you can make tactical investments according to size (for example, small-, mid- or large-cap stocks) or style (for example, value versus growth).
  
  
• With ETFs, you know exactly what you own; the composition of an ETF reflects the stocks in a specific index. With mutual funds, holdings are selected at the discretion of the mutual fund manager and need only be reported semiannually. The transparency of ETF holdings enables you to make sure your portfolio is properly diversified.

Pursue a variety of investment goals

• By purchasing an appropriate ETF, you can gain a balanced mix appropriate for your long-term view of the market or for your specific client profile. For example, if you believe that prospects are good for biotechnology companies, you can purchase an ETF representing that industry sector rather than buying individual biotechnology stocks.
  
  
• ETFs can complement a core investment style.

Gain tax efficiency

• ETFs help reduce your exposure to capital gains taxes relative to those incurred with many actively managed investments because index ETFs are not actively managed. Securities transactions in the index fund only occur when the underlying index composition changes and rebalancing is necessary, which tends to be rare.
  
  
• ETFs have a unique structure that makes them more tax-efficient, regardless of turnover. In traditional mutual funds, if an investor redeems his or her shares, the fund may have to liquidate positions and potentially generate a capital gains tax liability for the remaining investors. ETFs are not required to sell securities to meet investor cash redemptions because one investor's shares are sold to other investors through normal exchange trading.

Experience trading flexibility and convenience

• ETFs allow you to buy and sell an interest in an entire portfolio with a single transaction as easily as you could buy or sell an individual stock.
  
  
• They also allow you to obtain trade execution at the current market price, as with stocks, rather than at the day's closing price, as with mutual funds.
  
  
• You can buy or sell fund shares using market, limit or stop orders.
  
  
• Because ETFs trade like stocks, you are charged an execution fee or commission instead of a fund sales charge.

Enjoy lower expense ratios with passively managed ETFs than with actively managed funds

• With ETFs, you pay lower management fees because index fund management is less costly than active management.
  
  
• You bear lower fund transaction costs because of much lower portfolio turnover rates than most actively managed funds.
  
  
• You also bear lower record-keeping and administrative fees because most ETFs are bought and sold on secondary markets.
  
  
• As an additional benefit to individual investors, ETFs generally trade near their net asset value (NAV). The transparency into the complete list of holdings in the fund and the open market trading of the security generally eliminate the discrepancies between NAV and fund price that can occur in open- and closed-end funds.

Execute strategies designed to help optimize investment returns

• ETFs allow you to potentially increase returns and/or reduce risk in your portfolio by employing various investment strategies typically associated with individual equity investments.
  
  
• You can implement individual trading and hedging strategies with ETFs that have underlying options.
  
  
• With ETFs, you can hedge your long-term portfolio holdings against falling stock prices by selling short, which involves selling borrowed shares in anticipation of a price decline. Once prices fall, you can profit by buying back shares at lower prices. Be aware, however, that you risk paying more for a security than you received from its sale.
  
  
• Unlike stocks, ETFs can be sold short on a downward price movement.
  
  
• You can leverage your initial investment, borrowing against the value of your securities to purchase additional fund shares. This allows you to potentially participate in higher returns if stock prices increase. Note, however, that margin has associated risks and is only appropriate for individuals whose investment goals, time horizons and risk tolerance make aggressive investing appropriate. Keep in mind that if you buy ETFs on margin and stock prices decline, you will owe money in relation to that decline in addition to the amount you borrowed.²

Important considerations to investing with ETFs

• As with any investment, ETFs are not without risk. When stocks or bonds that are held in an ETF decline in price, the ETF's price will decline, too. And fixed-income ETFs, like the underlying bonds themselves, are subject to risks, including interest-rate risk. Meanwhile, investors who hold foreign market ETFs may be subject to currency risks and the same economic and political risks associated with holding foreign equities. ETFs may also trade at a discount to the portfolio's net asset value.

HOW CAN YOU GET STARTED?
If you're considering alternatives to stocks, bonds and mutual funds, ask a Merrill Lynch financial advisor about exchange-traded funds. A financial advisor can look at your finances in total and work with you to develop customized strategies that fit your goals, risk tolerance, investing style and time horizon.

For more complete information on exchange-traded funds, please ask a Merrill Lynch financial advisor for a prospectus. Before investing, carefully consider the investment objectives, risks, and changes and expenses of the fund. This and other information about the exchange-traded funds may be found in the fund's prospectus. Please read the prospectus carefully before you invest or send money.

1. International investing presents certain risks not associated with investing solely in the U.S. These include, for instance, risks relating to fluctuations in the value of the U.S. dollar relative to the value of other currencies, custody arrangements made for a fund's foreign holdings, political risks, differences in accounting procedures and the lesser degree of public information required to be provided by non-U.S. companies.

2. When using margin, investors should be mindful of the risks associated with leveraged investing. Margin investors can be called upon to deposit additional cash or securities if their account equity declines. Just like any equity, ETF share prices fluctuate. At liquidation, they could be worth more or less than their original price.