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Pros and cons of exchange-traded products

This article is part of
Guide to Exchange-Traded Products

When it comes to fees, Hortense Bioy, director of passive funds research at Morningstar, says ETFs have low annual expenses, especially compared with traditional actively-managed funds.

She says this is because there is no need to pay for an expensive fund manager or to hire research staff.

ETFs also offer investors the ultimate diversification tool, Ms Bioy adds.

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She says: “You can buy a little or a lot: ETFs have no minimum investment requirements, meaning investors can buy a single ETF or many.

“ETFs allow you to access a vast range of different investments, including bond indices, foreign market indices, and commodities like gold.

“ETFs trade on the stock exchange and can therefore be bought and sold throughout the trading day, unlike Oeics and unit trusts, which can generally be bought and sold only once a day.”

But on the downside in general, Ms Bioy says ETFs do not give investors the opportunity to outperform the market.

By contrast, she says other diversified investments such as traditional actively-managed Oeics and unit trusts are specifically designed to outperform the broader market, even though they do not always manage to achieve this goal.

She adds: “There are many different kinds of ETFs and ETPs, and some may not be suitable for all individual investors.

“For example, ETCs that track commodities using futures carry risks specific to the futures markets that need to be well-understood. The caveat ‘don’t buy what you don’t understand’ is always worth remembering.”

Managing portfolios

Ben Thompson, director of business development, listed products and ETF UK of Lyxor, says ETFs offer advisers the ability to manage client portfolios like an institutional investor.

Mr Thompson says ETFs are typically used by investors or advisers who are looking to build an efficient, low-cost core portfolio to capture long term growth.

He says: “The ability to target the whole risk spectrum from government bonds to individual emerging markets, or higher risk sectors such as financials or IT stocks makes them suitable for any investor.

“Plus, with a total expense ratio of between 0.15 per cent and 0.85 per cent, ETFs provide an ideal low cost vehicle to access these markets.

“The onscreen pricing, and ability to trade in or out on a daily basis means that ETFs can be used by more tactical investors too, who are looking to take advantage of short term trends in harder to reach markets.”

Like any investment, Mr Thompson says there are risks that advisers should be aware of.

He says capital is at risk and as these are only tracking investments, ETFs aim to achieve the return of the index being tracked. ETFs are not constructed with the aim of generating out-performance or ‘alpha,’ he adds.

Mr Thompson says there are investment risks too.

Due to the nature of some of the markets that ETFs can provide exposure too, Mr Thompson says the benchmark index tracked by an ETF maybe complex, and can be volatile, especially in some more remote emerging markets, or in the case of commodities.