Investing

You may well have read about ETFs recently. Exchange-traded funds are among the fastest-growing areas of Australia’s – and the world’s – financial markets.

As straightforward as buying shares

An ETF can be bought and sold on the ASX just like any other share. But instead of representing just a single company, these funds usually represent an entire index, or a commodity, or some other broader market. It’s like getting a managed fund – generally the passive index type – through a single share purchase.

Why buy an ETF? The idea is that they are an easy way of diversifying a portfolio. One purchase gets you exposure to, say, the whole Australian sharemarket, or a US index, or the gold price. Some financial planners think it makes sense to build a core portfolio out of ETFs and then make more active bets – a particular stock you really like, or a fund you would like to try – around the edges. They are cheap, too. It varies but they rarely cost more than 0.4 per cent a year.

Once upon a time ...

They began in this country with the SPDR S&P/ASX 200 fund, which State Street Global Advisors launched in 2001. This offering represents the Australian sharemarket and remains by far the most popular of these products today. State Street, which for years had the market to itself, later added an S&P/ASX 50 fund, and one for the S&P/ASX 200 Listed Property Index. Since then, more than 40 other offerings have followed, most of them in the past few years.

Excellent exposure

Through iShares, for example, you can use the funds to get exposure to foreign stocks. There are 23 iShares products and 19 of them are international, from global equity and emerging market indices to single-country funds based on, for example, China, South Korea or Taiwan. Through Australian Index Investments, among others, you can buy particular sectors of the local market, such as resources, metals and mining, industrials or financials.

Through ETF Securities you can buy funds that mimic the behaviour of specific commodities: gold, silver, platinum, palladium or a basket of all of them. And through BetaShares, in addition to some resource-related products, you can buy a fund that tracks the value of the US dollar – the first currency ETF in Australia.

Exciting new options

These offerings are becoming more popular. A couple of recent launches from Russell Investments and State Street don’t track a traditional index; one of the providers has invented a filter for high-yielding stocks. The idea of a fund like this is that it behaves in a steady way and produces a reliable income stream, particularly useful for retirees.

And in the future, they might become more complicated still. In markets such as Britain and the US, ETFs have been devised that are synthetic, rather than being backed by the things they represent. Others are inverse, meaning their performance is the exact opposite of the underlying investment. Some are leveraged or are based on derivatives – as is often the case for ETFs based on the oil price.

Most of these ideas have not yet arrived in Australia but are probably not far away; it’s vital to understand how they work before investing in them.

Advantages over LICs

Five years ago, funds like this tended to take a structure called a listed investment company, or LIC, but these days ETFs are much more popular. The main difference between them is that exchange-traded funds pretty much always represent the exact value of what they invest in – tracking an index precisely, for example – whereas LICs can be at a discount or a premium to their holdings. This has to do with the way the units are issued. ETFs are open-ended; the number of units on offer can increase or decrease according to supply and demand.

Anyway, this doesn’t matter much for the new investor. The point is that if you buy it, you know it’s going to track a particular index or commodity very closely.