With the cost of funds under the spotlight, we are seeing greater interest from advisers in exchange-traded funds. As these pooled investments tend to have lower costs than unit trusts and open-ended investment companies, more money is flowing into these investments.
With a background starting in the American investment Industry, at the end of the last century, there are now around 5,000 ETFs available globally of which over a 1,000 can be used in the UK - with steady stream of new launches. These funds give investors easy access to myriad investment markets.
In this article we will ask: what are ETFs, what do they do and what needs to be considered with regard to client suitability?
What is an ETF?
ETFs are part of a group of pooled investments, together with exchange-traded notes, certificates, currencies and commodities, which fall under the umbrella of exchange-traded products (ETPs).
An ETF – the most widely used ETP – is a collective investment which usually holds the types of securities one would expect to find in a fund, such as equities and fixed interest. The vast majority of ETFs track an underlying asset, usually an index, and therefore they are seen as the building blocks for a passive investment style.
(Note: contributing to their increased usage, active managers use ETFs to gain quick, and often short, exposure to markets.)
ETFs fall under the Ucit regulatory regime and are bought and sold through stock exchanges, stock brokers and brokerage platforms, like listed securities, rather than through an investment manager or their agent.
Unlike Oeics and unit trusts, which price once a day, on a forward basis ETF price regularly throughout the day, meaning investors can buy at a known price when markets are open.
The popular ones, such as FTSE All Share or S&P 500 trackers, which are available in the UK, tend to be domiciled in Ireland or Luxembourg rather than in the UK. Within the ETF world, bigger is normally better, with the largest funds having the smallest expense ratios and best liquidity.
Within the ETF world, bigger is normally better, with the largest funds having the smallest expense ratios and best liquidityWhat do they comprise?
With regard to how ETFs are put together, they are divided into two groups, similar to index tracking funds:
1. Physical ETFs
These track an underlying index through replication, which means holding securities which are intended to mirror the behaviour and performance of the indexitself.
