ETFs – is low-cost everything?
ETFs (Exchange Traded Funds) have become increasingly poplar with individual investors, advisers and self-managed super funds due to their low cost, transparency, and diversification benefits. Australian ETF investments grew from $21.3 billion to $27.2 billion over the last financial year. This represents an incease in funds under management (FUM) of 28% over the year to April 2017. And the size of the ETF market in Australia has more than doubled since 2014.
So, are ETF’s right for you?
The Basics
An exchange traded fund (ETF) is a managed investment fund that can be bought or sold on a stock exchange. In many ways, ETF combines the best parts of a managed fund with the best features of a listed investment company (LIC). But an ETF is not the same as either of these.
Structure
An ETF typically holds a series of underlying investments, and the purpose is to provide a convenient and efficient way for an individual investor to access to a broad range of underlying investments.
Passive investments
In Australia, most ETF’s are passive in nature, meaning:
They track some form of index and,
Their portfolio (of companies) are constructed in line with such an index.
The indices tracked can be broad-based or relatively narrow, so an ETF might track
Only a particular sector of the Australian market such as agriculture or the Australian resources, or
A broad-based market index such as the ASX 200.
Why are ETF's popular?
Traditionally, index fund investors have been attracted by low transaction costs and low holding fees – two particular features of an ETF that have undoubtedly helped explain the increasing popularity of this type of investment.
Advantages of ETF's
Buying and selling
You can buy and sell ETF units on the ASX the same as shares in ASX companies;
People mostly trade using an online brokerage service;
As with all shares bought and sold on line, the transaction usually happens immediately;
Settlement for the trade takes place within the next two days (ASX trading rules);
The ability to access and trade through the ASX is one of the main advantages of ETF’s;
Whereas, trading in unlisted (on ASX) managed funds, often involves a substantial delay between the time of a buy or sell order and when the transaction actually takes place.
Low fees
ETF’s typically impose a much lower fee on unit holders, eg
Vanguard Australian index share ETF fee is 0.14% per annum (p/a) vs
Vanguard Australian index share managed fund fee can be as high as 0.75% p/a
As both investment vehicles hold the same underlying assets, the ETF is a much more efficient way to get the same return before fees.
Diversification
Diversification is the main reason for any form of managed investment.
This means that most ETF’s hold a substantial range of investments:
which helps you ride out the ups and downs of financial markets
however these are NOT a guarantee against financial loss;
the value of an ETF can rise and fall daily, usually in line with the index it is tracking;
the reason for indexing is to achieve the average returns to be expected from a diversified portfolio with minimal transaction and holding costs. The substantial cost advantage enjoyed by ETF’s makes ETF’s very attractive to passive investors.
However, low-cost isn't everything!
Here are 5 other things to consider before you choose an ETF:
Check the actual holdings - ETFs with similar names can nevertheless have big differences in the makeup of their holdings ( see
Trading fees – that you pay for trades via your broker- can add up quickly, especially if you do a lot of trades, as can buy -sell spread (see MoneySmart for tips)
An ETF can be mispriced due to tracking errors
There may be some markets and market conditions where active investments perform better than ETF's
Any returns you make on your on ETF's are taxed, as returns =taxable income! However,
ETF's generally have lower capital gains tax than most active funds - there is a low rate of portfolio turnover as ETF’s track an index rather than buying and selling stocks regularly,
If your ETF tracks Australian shares, you may get a franking credit to offset tax payable
The RBA has also noted the following concerns:
Liquidity risk ie [some] ETF’s may be harder to sell at times of market stress
The expanding ETF market includes more complex ETF’s which can be higher risk
Transparency
As outlined above, ETF’s are subject to the same listing rules as all other listed securities. One of these requirements is continuous disclosure , which requires the listed entity to keep the market informed of all material information that might affect its share price. This includes basic information about the fund such as its investment philosophy and holdings.
Next steps:
Contact Elizabeth for a chat about how ETF’s might work for you in your super, or as an investment outside super.
You can check out this link to the ASX for more information about ETF's.
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