Exchange Traded Funds (ETFs) are Managed Funds listed on an exchange that can be purchased or sold in the same way as normal shares. ETFs are diverse and cover a broad range of investment types and asset classes from index tracking share portfolios to commodity ETFs and bond ETFs. Exchange Traded Funds also provide exposure to specific investment types, for example some ETFs target value stocks, some weight each stock equally, some target growth stocks etc… ETFs can be ideal for small accounts and people getting started in the market as you can obtain diversified exposure to a market, a sector or an asset class with only a small amount of capital. Further you can diversify across ETFs in the same why in which would would a share portfolio. ETFs targeting a stock index are also less volatile than individual shares as the fund typically holds a full portfolio of shares based upon an underlying benchmark index like the S&P500, where the ETF would be holding the 500 shares that make up the index.
Why Invest in ETFs?
Low cost alternative to traditional funds
Simple diversification across a basket of assets
Easily hedge broad market exposure
Benefits of Investing in ETFs
The main benefits ETFs have over normal unlisted managed funds are that they are listed on an exchange so can be purchased and sold quickly and easily, the fund is very transparent in that it is designed to track an index, sector, bond or commodity, you can obtain diversification for a low capital outlay and the fees are typically lower.
Where most Managed Funds can be purchased and sold based upon their end of day pricing after the market has closed ETFs are traded live on an exchange and can be bought and sold during exchange market hours.
Given the liquidity benefits of an ETF it is easy to move money between specific asset classes, such as stocks, bonds, or commodities. Based upon the investors overall economic outlook investors can re-weight their portfolio to reflect their outlook far more easily than with non listed funds.
Investors in ETFs also get the flexibility of trading the ETF like a stock. This means the investor can set limit, market or stop orders and even trade the ETF on an intraday or short term basis. Another advantage is that Margin Lending facilities may also be available meaning more aggressive traders can utilise leverage to potentially increase returns during favorable market conditions.
For those investors with a contrarian view an ETF listed on an exchange can also be shorted meaning the investor will profit if the ETF price moves down (as opposed to up). Further inverse ETFs which move up when the market moves down and vice versa can also be utilised as a hedge if the trader wishes to protect his or her portfolio.
Portfolio Diversification and Risk Management
The huge variety of ETFs allows Traders and Investors to allocate their investment funds towards many different types of ETFs based upon their view. The types of ETFs include Index Tracking ETFs on US Markets, Index Tracking Funds on International Markets, Currency Tracking ETFs, Commodity ETFs, Bonds ETFs, Industry and Sector ETFs, Style ETFs, Derivative ETFs, Leveraged ETFs, Inverse ETFs, Actively Managed ETFs, Dividend ETFs and more. With the large range of ETFs available investors can gain exposure to a wide range of asset classes in which to diversify their holdings.
You can trade ETFs on virtually all major stock exchanges around the world. With the different types available such as inverse ETFs that allow investors to hedge a broad market index, or volatility ETFs that provide protection in volatile market moves, to value or growth ETFs there is an ETF to suit almost any investment theme or style. Another advantage is that because most ETFs provide exposure to a portfolio of shares they are lower risk than buying individual companies and as such, less volatile.
For beginner traders ETFs are ideal because stock selection in not important as index tracking ETFs will give you exposure to an entire index meaning research time can be reduced significantly. In addition smaller investor can gain exposure to a wide range of stocks with only small amounts of capital.
Sector and Industry ETFs provide exposure to companies representing a sub set of a market like technology, industrial, energy, real estate, health care, biotech, mining and more. Investors are all able to go long or short an ETF and gain more specific hedges if the intention is to protect capital in a certain sector or industry. For example, an investor may have a large number of restricted shares in the semiconductor industry. In that situation, the person may want to short shares of the Standard & Poor’s (S&P) SPDR Semiconductor. That would reduce one’s overall risk exposure to a downturn in that sector. XSD is an equal-weighted market cap index of semiconductor stocks listed on the New York Stock Exchange, American Stock Exchange, NASDAQ National Market, and NASDAQ Small Cap exchanges.
One of the main advantages of ETFs is their relatively low cost structure. Most off exchange Managed Funds typically charge between 1% and 2% per year as a management fee, which is made up of Trustee Fees, Custodial Fees, Unit Pricing Fees, Performance Fees, Licensing Fees and Administrative Fees. ETF fees are usually much lower and are typically in the range of 0.3%-0.7% per year.
The cost savings can be attributed to lower front office costs as ETFs are typically recommended by brokerage firms who provide most of the administrative and reporting services to the customer. Further performance fees and redemption fees are also reduced or non-existent. With Index ETFs there is a need for only a small research team as the funds tracks an index so stock selection is a non issue as they are held in the same weighting as the underlying market, sector or industry they are tracking.