Exchange Traded Funds (ETFs)

Exchange Traded Funds or ETFs are a simple way to create a diversified portfolio. They are traded on the Australian Stock Exchange in the same way as shares.

An ETF generally invests in a basket of shares that makes up a particular index and there are an increasing number of ETFs to choose from. You can also choose to invest in ETFs over currency or commodities.

 Why invest in an ETF?

There are a number of reasons why you might want to invest in an ETF. Let’s explore a few:

Diversification

ETFs allow you to diversify your portfolio without having a large amount of money to invest. The broad investment exposure helps you to avoid concentration risk which can occur if you don’t diversify across and within asset classes.

Liquidity

You can buy or sell ETFs just like any other share and this means that you can quickly liquidate your holding to respond to changing market conditions.

Transparency

ETFs give you a high level of transparency as a full list of the underlying holdings is provided to the market each day.  This allows you to see the exact nature of the underlying exposure. The Net Asset Value or NAV should also be available on a regular basis.

Portfolio construction

You can easily use an ETF to complement other investments in your portfolio.  Visit the Russell Investments site and under the information on their high dividend ETF there are a number of case studies explaining how ETF’s might be used. 

Costs

ETFs generally have lower ongoing costs than actively managed funds and the brokerage is generally less expensive than purchasing a large number of individual parcels of shares.

However, ETFs can be harder to invest in if you want to invest small regular amounts because of the brokerage you need to pay for each purchase.

Tax effective

ETFs can be quite tax effective as they generally have a lower level of portfolio turnover than actively managed funds.

 Types of ETFs

There are two types of ETFs:

Conventional

This type of ETF tracks the performance of an index by owning all or a sample part of the underlying index, when the index changes the ETF manager needs to rebalance its portfolio by buying or selling the share to align with the index.  A range of factors including costs, timing, cash balances associated with changes and distributions can result in tracking errors.

Synthetic

This type of ETF tracks the performance of an underlying index by owning a basket of shares but also enters into an agreement with a counterparty to ensure the closest possible tracking of the index. They are easy to identify as they have ‘synthetic’ in the product name.

 ETF checklist

Before deciding to invest in ETFs you may want to consider the following questions:

  • Have you set your overall asset allocation and where do ETFs fit into that allocation?
  • What ETFs are available to meet your asset allocation requirements? Are they conventional or synthetic?
  • Is there is a choice between multiple ETFs? Do you need to do further research into the composition of the ETF, the ETF issuer and other potential risks before making a decision?
  • How easy is it to check the portfolio holdings of the ETF?
  • How often is the NAV updated and published?

 More information

Explore a range of online tools such as ETF performance date, market updates and investor and educational research on the ASX website.

You can also do further research at the ETF issuers' sites.

Russell Investments

State Street Global

Vanguard Investment

IShares

Australian Index Investments

Beta Shares

Alternatively you can explore some of the commercial sites. Remember these sites do have products to sell, but you can take advantage of the learning components:

ETF Mate – a comprehensive website provided sound education and research on ETFs

Morningstar – news and articles focusing on ETFs