Investing in ETFs
Exchange traded funds (or ETFs) have experienced a huge boost in popularity both in Australia and around the world over the past decade. With an explosion of new ETFs offered that cover almost every conceivable investment market, asset class, and investment style, ETFs are now one of the most popular ways to express an investment view in a portfolio.
In Australia, an ETF is a registered managed investment scheme. Investors in an ETF own units in that fund, on a proportionate basis. The ETF itself invests into an underlying portfolio of assets.
The key difference with ETFs compared to regular unlisted managed funds is that ETFs are traded on the stock exchange (ASX) just like shares, and hence are easy to buy and sell via a stock broker or online trading account. This ease of access and transaction capability is a big driver of the worldwide growth in ETFs.
ETFs are available across pretty much the entire spectrum of asset classes these days. You can find ETFs that provide exposure to:
Not only that, there are many ETFs that then enable an investor to take a specific (or a mix of specific) exposures with an asset class.
For example, within Australian shares, ETFs are available for investing in just certain sectors such as resources, or financials etc. Similarly for global shares, exposure to just healthcare or telecommunications (among others) are available. Within fixed interest, specific exposures can be created for sectors such as Government bonds or corporate bonds, or floating rate bank bonds etc. In commodities, ETFs are available that cover an index, or specifics such as Oil or agriculture etc.
At the next level, ETFs have also been created to enable investors to get access to specific investment strategies. One example is an ETF that does a strategy called buy-writes (or covered calls). To do this as direct investor is possible, but not straightforward and requires knowledge of options and opening an options trading account etc. The ETF provides a convenient easy option to gain exposure to that strategy.
The list of options has grown very large, with a large variety of combinations now possible.
ETFs originated as ways for investors to gain a low cost exposure to an entire index, such as a stock market index. This was known as “passive” investing as the underlying investments are selected purely based on belonging to the index that the ETF is tracking.
These types of ETFs that track an index or the price of an asset (such as Gold for example) are known as “passive” ETFs.
As time went on, a new type of ETF emerged, which is known as the “active” ETF. In this scenario, the manager of the ETF is trying to outperform their relevant index by selecting the underlying assets based on their skills as a fund manager. In this way, it is very similar to how most active managed funds operate. Active ETFs tend to have higher management fees than passive ETFs, as more is required of the fund manager.
Physical ETFs are those that actually buy the particular underlying asset (such as shares or bonds) within the index or strategy that the ETF is following.
Synthetic ETFs are those that use the derivatives markets (such as the options or futures markets) to a significant degree to create the exposure to the underlying assets that the ETF is meant to be tracking. Depending on the liquidity, volatility, and spreads of those derivatives markets, this can mean that there can be deviation from the actual result of the ETF and the price movement of the physical asset.
ETFs are not without risks, and its important for investors to fully consider each individual ETF on its merits.
Lonsec provide comprehensive research on ETFs, with it’s Viewpoint reports providing information of what the fund is, performance tables, how to use the fund in a portfolio, the “rating” of the fund, Lonsec’s overall opinion of the fund, fund manager profile, Lonsec’s suggested risk profile suitability, and it’s strengths and weaknesses.
CLICK HERE for more information on research for ETFs.
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