An ETF is an 'exchange traded fund'. It is an index-tracking fund which is listed and traded on a stock exchange market. An ETF tracks whole indices such as the FTSE100.
You may buy ETFs as you would buy any other stock, at any brokerage firm.
As ETFs track the performance of a particular index, their base price is basically equivalent to the value of the index.
Given their nature as funds containing openly traded securities, investors should bear the following points in mind when trading ETFs:
- Neither the capital nor the dividends are guaranteed
- As the assets under management are stocks they are vulnerable to stock price fluctuations
- Close tracking of the underlying indices can be difficult during periods of market volatility.
- Comprehensible and easy to use
As ETFs track indices which can readily be accessed in newspapers and on television, their prices are easy to understand.
As ETFs mirror the market as a whole there is no need to investigate individual companies' financial and business results, thus simplifying investment decisions.
- Lower Risk
Unlike investing in individual stocks, ETFs offer the benefits of a diversified portfolio covering the underlying index's component stocks. In other words, the risks involved are reduced by spreading them across a wide portfolio.
- Constant Trading during open market hours
Ordinary unit trusts can only be bought and redeemed at the daily base price.
In contrast, ETFs can be traded at any time during open hours. So investors can check prices and place orders as they do for stocks.
As ETF prices mirror the underlying index, they can move up and down. Investors can follow and exploit these movements allowing them to plan their transactions on a real-time basis.
- Readily Available
Unlike, unit trusts/OEIC’s, ETFs are available through all UK brokers.
- Low Costs
Investors can gain exposure to literally hundreds of securities through a single transaction. As there is no need for fund administrators to produce prospectuses, nor any need to buy and sell assets at subscription and redemption, management costs are minimised.
ETF transactions are subject to the same fees as share transactions. They are subject to Income and Capital Gains Tax in the same way as equity and there is a small management charge levied by the issuer.
The wide range of trading strategies available using ETFs mean that they can be suitable for the largest institutional investor through to the private investor. Although a passive tool, ETFs are commonly utilised as part of active strategies in conjunction with other funds or individual securities. ETFs are also useful in short term tactical plays as well as longer term investments. Suitability depends on the specific requirements of the individual investor and those unsure should seek professional advice.
ETFs are typically very cost-efficient. However like other securities, every time an investor makes a purchase or sale they must pay brokerage costs. In addition the ETF investor can suffer from the usual costs of trading securities, such as differences in the bid-ask spread.
The unique structure of ETFs offers several advantages to investors:
- Buy or sell at any time during the day, not just at the end of the day as is the case with managed funds
- Invest in a portfolio of securities with one trade