ETFs: how exchange-traded funds work

You have probably seen the acronym “ETF” next to index names such as the Ibovespa or the S&P 500. ETF stands for exchange traded fund. In Brazilian regulation, the official name is fundo de índice (index fund).

This article explains how this type of fund works, which rules the CVM (Comissão de Valores Mobiliários, Brazil’s securities regulator) imposes, what costs and risks exist and how income tax applies, based on rules checked on October 8, 2026. It does not recommend any specific fund.

What an index fund is

A market index is a theoretical portfolio of assets, with public rules about which ones are included and with what weight. The Ibovespa, for example, brings together stocks traded on B3, the Brazilian stock exchange. The index itself is not an investment: it is a measure.

The index fund tries to turn that measure into something you can buy. Normative Annex V of CVM Resolution 175, which deals with these funds, defines the index fund as intended for a portfolio of assets “that aims to reflect the variations and returns of a reference index” (Art. 2).

CVM Resolution 175 is the general rule for investment funds in Brazil. The CVM page lists later amendments, the most recent being Resolution 240/26.

Some rules in the annex help to understand the product:

• Portfolio tied to the index. The fund must keep at least 95% of its assets in instruments that make up the index, positions in futures contracts or shares of other funds that track the same index (Art. 41).
• Index with public rules. The CVM only accepts indexes with a complete methodology available free of charge online, predetermined rules and a clear investment objective. The index provider cannot be a related party of the administrator or the manager (Art. 2, § 2).
• No leverage or contrary bets. Leveraged, inverse (seeking the opposite of the index) and synthetic classes, which replicate the index using derivatives only, are prohibited, except for the futures provided for in the annex (Art. 3).
• No performance fee. The index fund cannot charge a performance fee (Art. 7).
• Mandatory trading. Shares must be admitted to trading on an organized market, such as the stock exchange (Art. 5, sole paragraph).

Two doors: the exchange and share creation

There are two ways an ETF share changes hands.

The first is the one you use as an ordinary investor: buying or selling shares from another person on the exchange, at the current price, as you would with a stock. In this case, the fund neither receives nor returns money; only the owner of the share changes.

The second is the creation and redemption of shares, usually carried out by large participants. Here, whoever subscribes delivers to the fund a basket of assets defined by the manager (or cash, depending on the fund’s rules) and receives new shares. In a redemption, the path is reversed. The annex allows this basket to contain up to 5% of assets outside the index (Art. 12) and requires that issuance and redemption use the share’s net asset value at the close of the day (Art. 14).

This second mechanism is what tends to bring the share’s price on the exchange close to the value of the assets it represents. If the share becomes too expensive relative to the portfolio, it pays to create new shares and sell them; if it becomes too cheap, it pays to buy and redeem. The rule does not guarantee that the two values will be equal at all times, and on days of thin trading the gap can widen.

To provide liquidity, the fund may rely on market makers, institutions that maintain buy and sell offers. The fund manager cannot play this role (Art. 18), and the list of authorized market makers must be on the fund’s web page.

What you need to check: transparency

The annex requires the fund to keep a web page with, among other things (Art. 31):

• portfolio composition updated daily;
• fees and expenses, prominently displayed;
• the risks involved and applicable taxation;
• a table with the fund’s monthly return compared with the index’s, covering at least 24 months;
• the index methodology.

This information answers the practical questions: what the fund holds, how much it charges and how close to the index it has stayed.

Why the ETF does not deliver exactly the index

The index has no cost; the fund does. Management fees, brokerage and other expenses come out of the fund’s assets, so the fund’s return tends to fall slightly below the index over time. Differences in the timing of buying and selling assets and the treatment of dividends also pull the two apart.

The CVM measures this gap. Tracking error is the standard deviation of the daily differences between the change in the share and the change in the index over the last 60 trading sessions. The administrator must call a shareholder meeting when (Art. 27):

• tracking error exceeds 2 percentage points and does not return to the limit within 15 business days;
• the cumulative return difference over 60 sessions exceeds 2 percentage points, under the same conditions;
• the cumulative difference over 12 months exceeds 4 percentage points and does not return to the limit within 30 business days.

For fixed income ETFs, these limits drop to 1, 1 and 2 percentage points.

Risks that remain

Buying an ETF does not reduce the risk of the market it tracks. If the index falls, the share falls with it. In an equity ETF, you can lose a significant part or all of the amount invested. For a general comparison between investment families, see fixed income and equities: risks and characteristics.

Other risks to watch:

• Liquidity. If few people trade the share, it may be hard to sell without accepting a worse price.
• Concentration. An index may have few assets or a dominant sector. Diversifying within an index is not the same as diversifying across markets.
• Currency. ETFs that track foreign indexes also move with the currency.
• Interest rates. Fixed income ETFs fluctuate in price when interest rates change, just like the bonds in the portfolio. The mechanism is the same as described in Tesouro Direto: bonds, rates and risks.

Cost, even if small, also matters in the long run, because it reduces the base on which returns compound. The logic is in compound interest: how it works in practice.

How income tax applies

Taxation depends on the type of ETF. The rules below were checked against the consolidated texts of the laws on October 8, 2026. Provisional Measure No. 1,303/2025, which proposed changes, appears in these texts with the note “validity ended”; the previous rules remain in force.

Fixed income ETF. Law No. 13,043/2014, Art. 2, covers funds that track fixed income indexes and keep at least 75% of the portfolio in index assets. The rate depends on the portfolio’s average repricing term, a measure of how long, on average, it takes for the bonds to mature or have their rate reset:

Portfolio average term	Rate
Up to 180 days	25%
181 to 720 days	20%
Over 720 days	15%

The tax is withheld at source on sale, redemption or distribution of income. If the fund breaches the 75% minimum, the rate becomes 30% while the breach lasts.

Equity ETFs and other variable income indexes. Selling shares on the exchange generates a net gain taxed under the rules for exchange transactions: 15%, or 20% for day trades (buying and selling on the same day), according to Art. 2 of Law No. 11,033/2004. The exemption for sales of up to R$ 20,000 per month, provided for in Art. 3 of the same law, mentions stocks on the spot market and gold as a financial asset; index fund shares are not on the list.

If the ETF distributes income, Law No. 14,754/2023 provides for 15% withholding at source for ETFs that meet the requirements of the specific regime (Arts. 18, 22 and 24). The same law exempts these funds from the periodic advance taxation known as “come-cotas,” which applies to other funds (Art. 24, § 1).

Tax rules change and have details that depend on your situation. Before filing, check the guidance from the Receita Federal (Brazil’s federal tax authority) or consult a professional.

Key takeaways

• An ETF is an index fund regulated by the CVM: a portfolio with at least 95% linked to the index, public rules and shares traded on the exchange.
• It tracks the index but does not reproduce it perfectly; costs and tracking error pull the two apart, and the CVM sets limits on this difference.
• The risk is that of the market being tracked, including total loss. The tax changes depending on whether the ETF is fixed income or variable income.