Exchange Traded What? - Part 1

So you’ve heard about ETF’s, your mate told you they bought some and your boss has a few in their SMSF. That’s great, but what are they exactly?

ETF stands for exchange traded fund, simply being the asset is traded on an exchange (like the Australian Stock Exchange) and is a fund run by a fund manager. The more traditional and still widely used Managed Fund differs in simplistic terms by how it is transacted by investors.

So how do ETF’s work?

An ETF aims to track the value of an index, commodity, currency, basket of thematic assets or other assets.

An example of this is the Vanguard Australian Shares ETF (VAS) – it aims to passively replicate the returns for the ASX300 (top 300 listed companies by market capital in Australia).

In essence, by buying one share of VAS, you are buying a tiny stake in each of the ASX300 companies. Vanguard is the manager of the fund and makes sure that the weightings in each company are correct and will re-balance when required by their mandate.

Other ETF’s can track the price of a commodity like Gold, a currency like the US Dollar, fixed income assets like corporate and sovereign bonds or a thematic basket of companies like ETFS’ FANG+ which holds 11 of the big US technology companies.

With the recent popularity and uptake in ETF’s, there has been an influx of new products to the market in all sorts of sectors including crypto currency ETF’s, the obesity ETF and video game ETF’s.

What are the benefits of ETF’s?

· ETF’s are a great way to diversify your portfolio and access markets that might normally be difficult or expensive to invest into.

· Some of the larger, more passive ETF’s are considerably less expensive than other investment types including managed funds.

· Everyday, each ETF manager details the net asset value of the ETF’s holdings, this can be compared to the ETF share price for complete transparency.

· With the cost of brokerage on its way down in Australia, the cost to access ETF’s is better than ever.

What should I be looking out for?

There are a few points you should consider before deciding on where to invest. These can include:

· Portfolio/ Market Risk – how risky are the assets that the ETF is invested in? Does this fit my risk profile? What is my investment timeframe?

· ETF Management Cost – each ETF manager charges a fee to manage the fund, this can be anywhere from 0.03% to 2-3% or more. Most published returns by ETF providers will be net of the management fee charged.

· Physical or Synthetic – does the ETF actually own the assets they tell you they hold? If they don’t, they are synthetic and should tell you. There is added counterparty risk with synthetic ETF’s.

· Currency Risk - if the ETF invests in international assets, you face the risk of currency movements impacting your returns. Some ETFs are 'currency hedged' which removes this risk.

· Liquidity Risk – some smaller ETF’s have limited liquidity and larger spreads which can

make buying and selling more difficult.

The Bottom Line

ETF’s can provide a great starting point for a new investor who doesn’t want the pressure of picking individual stocks or for a seasoned investor looking to add an asset class in a simple and cost-effective way to their portfolio.

As always, you should do your own research before you invest in any product so you can decide if it is right for you.

Here at Hunter FP, we can help with ETF portfolios, both through an investment account or your super, if this sounds like something you would be interested in call us now to organise an obligation free consultation to see how we can help.

The ETF examples mentioned in this blog are in no way affiliated with Hunter FP and do not constitute personal financial advice.

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