Diversify Your Portfolio with Exchange Traded Funds

Exchange Traded Funds, or ETF’s as they are commonly known, have quickly become one of the most popular investments on the Australian Stock Exchange (ASX). While their popularity soars, exactly what an ETF is remains a mystery to some. In this article we look at what ETF’s are and why they have become one of the hottest investments on the ASX.

What is an ETF?

ETF stands for ‘exchange traded fund’, and as the name suggests, they are a type of fund which is traded on the stock exchange. ETF’s are similar to a managed fund, in that they generally hold a number of different stocks, bonds or other investments, based on an index, asset class or sector. Unlike a managed fund, the units in these funds are bought and sold through the Australian Stock Exchange.

There are currently over 140 different ETF’s on the ASX, with the majority of these being ‘passive’ style investments. This means that they track an underlying indices or benchmark, and do not try to outperform the market, but simply mirror it. An example of an ETF would be VAS, which is a Vanguard ETF which tracks the ASX300 index. This ETF buys all of the equities which comprise of the ASX300 index, in the same weightings. Units, or shares in this ETF, are then sold on the stock exchange.

How are ETF’s bought and sold?

ETF’s are bought and sold on the ASX, the same way as individual shares are bought and sold. If you have a share trading platform, it is as simple as submitting a buy or sell request. As with the purchase or sale of any share, there are costs involved in these transactions which need to be considered. These costs can mount quickly if you are trading on a regular basis. The buy-sell spread should also be considered when purchasing and ETF, particularly if you only intend on holding the units for a short period of time.

What are the advantages of an ETF?

One of the primary reasons behind the emergence and popularity of ETF’s is the advantages they over traditional managed funds. These advantages include;

• Lower buying price – using our VAS ETF as an example, the shares in this fund are currently trading around $82 per share. The minimum amount of shares you would be required to buy depends on our trading platform, but if possible, you could enter the share market for $82. The Vanguard product tracking the same index as a traditional managed fund requires a minimum $5,000 investment.
• Liquidity – The ability to by and sell these ETF’s quickly, particularly for retail and novice investors, makes them very appealing. While traditional managed funds will handle the sale of your units on your behalf, ETF’s allow you to place an order yourself, at a price you are happy to either buy or sell for.
• Dividends – Like any other share, ETF’s pay dividends based on the dividends received from the underlying assets. As most of theses ETF’s are passive the fees paid to manage them are generally lower. Therefore a larger portion of the dividend is returned to you.
• Diversification – As these ETF’s have a lower purchase price, this provides multiple options to diversify your portfolio with less funds. The ASX broadly categorises their ETF’s into 18 different exposure groups. These include equities, sectors, commodities, property, fixed interest, cash, strategy, currency and mixed asset across Australian, Global and Asian markets. In traditional managed funds, the higher initial purchase price limited most retail investors to only a few different funds at best. By using the lower priced ETF’s, it is possible to  invest in all 18 exposure groups for the cost of investing in a single high priced managed fund.

What are the risks of ETF’s?

The risks associated with the purchase and holding of an ETF are very similar to the risks of hold any other share or equity. These include;

• Market risk – the risk of falling market values is a primary risk given the majority of ETF’s track market indices, . This is the same for any managed fund tracking an index.
• Currency risk – for ETF’s with currency or global exposure, there are risks associated with the changing exchange rates of currency. This may effect the dividends received or interest received as well as the underlying values of the assets.
• Interest rate risk – the changing of interest rates will have a effect on the performance of certain ETF”s. These include funds with high exposure to fixed interest securities or bond markets.
• Tax risk – as many ETF’s have exposure to global markets, foreign tax laws, and changes in these laws, may effect fund returns.

If you would like to learn more about ETF’s, give the team at Steve May Financial Services a call and start a conversation today.