What Is An ETF?

What Is An ETF?

An ETF is an open-ended investment fund, similar to a traditional managed fund, that is traded on the ASX – just like any share. ETFs aim to closely track the performance of a given index or asset class and provide the returns of that index or asset class – less any fees.

They offer simple to use, transparent, low cost and flexible investment options for investors.

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Advantages of ETFs

  1. Simplicity

ETFs help investors gain exposure to a range of investment strategies, geographic regions and asset classes, and can be bought as simply as buying a share.

  1. Liquidity

ETFs are traded on the Australian Securities Exchange (ASX) so can be bought and sold during the trading day.

  1. Transparency

Information relating to ETFs, including underlying portfolio holdings and fees, can be accessed at any time via the fund manager’s website.

  1. Cost-effective

Because ETFs either aim to simply track the performance of an index or asset class or rules-based methodology, there are no in-built ‘active management’ fees to worry about.

  1. SMSF friendly

Just like shares, ETFs are eligible to be bought inside Self-Managed Super Funds, and the popularity of ETFs has been growing strongly with this client base.

How do investors use ETFs?

ETFs offer investors flexibility for a wide range of investment strategies. Some examples include:

Portfolio construction and asset allocation: ETFs can be used as core holdings in a portfolio and as building blocks for portfolio construction.

For example: A ‘sector’ ETF can be used by an investor in order to simply obtain exposure to a particular industry sector such as government, corporate or floating rate bonds.

Core / Satellite strategy: ETFs can be used to build a core portfolio of broadly diversified indices or asset classes. Single individual stocks or bonds can then be added as alpha generating ‘satellites’.

Investing in ETFs

Buying and selling units in ETFs is as simple as buying or selling any investment on the Australian Securities Exchange.

How to buy and sell ETFs

Buying and selling an ETF is very straightforward. ETFs trade exactly like shares, so if you are able to buy and sell shares than you are able to buy and sell ETFs! Like shares, ETFs can be bought and sold at any time during the ASX trading day through a stockbroker. That means there is no need open a separate trading account beyond your existing share brokerage account. Once your brokerage account is established, the ASX ticker of the fund is used make a purchase or sale, without the need for any additional paperwork. In addition, this also means there is no minimum investment requirement, beyond that stipulated by your broker.

What are the risks of ETFs?

The primary risks of investing in ETFs come from the investment risk associated with investing in the asset class or strategy that the ETF provides access to. For example, if you invest in an ETF which provides exposure to the broad Australian sharemarket, then naturally movements up or down in the sharemarket will generally lead to positive or negative investment performance in the ETF. For more information on the risks of a particular ETF, please see the relevant product disclosure statement (PDS).

Where are my assets held? What happens if the product issuer goes bankrupt?

ETFs are regulated unit trusts whose units trade on the ASX much like shares. They have the same legal structure as traditional managed funds and are subject to the highest form of investor protection regulation available in Australia.

The assets underlying ETFs do not form part of the assets of the product issuer. Rather, they are held on trust for the benefit of unitholders. As an extra layer of separation, the assets are normally held by an independent third party custodian appointed by the ETF issuer. This essentially means ETF assets are not available to creditors of the issuer in the unlikely event of a default.

I don’t see many ETF units being bought and sold during the day, does that mean ETFs are illiquid?

The open-ended structure of an ETF means that the liquidity of the ETF goes significantly beyond the amount of ‘on-screen’ volume an investor may see on the trading screen. In fact, the liquidity of an ETF is generally at least as much as the liquidity of the underlying assets held by the ETF.

This article first appeared on the BetaShares website and is republished with consent.