What are ETFs

ETFs are index tracking funds that are traded on an exchange such as the London Stock Exchange. They combine the ready-made diversification of unit trusts with the simplicity of shares. They are eligible for ISAs but attract no stamp duty, ETFs have some of the lowest annual charges of all collective investment schemes. First introduced in 2000, there are now a number of ETFs available, tracking equity and fixed income indices in the UK and around the world.
 
In 2006 the London Stock Exchange became the world’s first exchange to offer a multi-currency trading service for ETFs giving investors a tax-efficient and currency risk-free alternative to buying ETFs in the US markets.
 
A summary of how ETFs compare to similar products:

ETF

Unit Trust

Investment Trust

Structure

Open-ended. Price directly linked to NAV

Open-ended. Price directly linked to NAV

Closed-ended. Price indirectly linked to NAV and driven my market

Trading

Anytime during market hours at real-time prices

Once a day on unknown future prices

Anytime during market hours

Buy

Through a broker

From Fund Manager, Supermarket or IFA

Through a broker

Unit/Shares price

Close to NAV (minimal tracking error)

At NAV (once in 24 hours)

At discount or premium

Investment style

Tracker

Active or Tracker

Active (small no. of tracker)

Stamp duty (on purchase)

No

No

Yes

Initial charges

0 + broker's fee

Up to 1% & broker’s fee (if through broker)

Typically 0 + broker’s fee

Annual charges

0.20 - 0.75%

Up to 1.75%

Typically around 1%

PEP/ISAble

Yes

Yes

Yes

With ETFs the fees are minimal, and trading is much more convenient. You don’t have to write off a whole load of forms, you can buy and sell within a day.
Justin Urquhart-Stewart, 7 Investment Management.