What is an ETF?
An ETF or Exchange Traded Fund is a collective investment scheme, typically formed as an open-ended investment company, that is listed and traded on a recognised stock exchange. The majority of ETFs are passive and aim to track a market benchmark or index, for example an equity index such as the FTSE 100 or a bond index such as the iBoxx GBP Gilt index . They typically offer a well diversified and low cost means to gain exposure to the returns of a particular asset class, such as UK government bonds or Japanese equities. As they are exchange traded, they can be bought and sold at any time during market trading hours unlike traditional funds which generally trade once a day.
What are the risks of investing in ETF?
There are also some specific risks to note when investing through an ETF:
- As ETFs are exchange traded, the price can depend on market liquidity. This means that you are not guaranteed to buy or sell at the true value per share value, known as the net asset value (NAV). Trading above the NAV is said to be trading at a premium, and below the NAV at a discount.
- ETFs aim to track an underlying index; however, they will not do this perfectly and some ETFs will be better at tracking the index than others. We refer to the difference as the ETF’s tracking error.
- In order to track the returns of the desired market index an ETF may purchase the underlying securities that make up this index. This type of ETF is often referred to as physically backed. Alternatively, the ETF manager may enter into an agreement with a third party (usually a bank) to exchange the returns from cash invested into the fund for the returns of the underlying market index it is aiming to track. This type of ETF is often referred to as a synthetic ETF.
Why do you invest in ETFs?
Netwealth aims to minimise the costs of investing for clients. By making use of ETFs we can gain market exposure to various asset classes at a low cost. ETFs are, in most cases, passively managed which means that they have low management charges. ETFs also have the added flexibility of being able to be bought or sold at any time during market hours. It will not always be appropriate to use an ETF to gain exposure to a market and so we will always consider ETFs in the context of all available securities.