Pros and cons of exchange-traded products

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.

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.

Mr Thompson says currency risk can be an issue too if the ETF is denominated in a currency different to that of the benchmark index they are tracking. In this case, Mr Thompson says exchange rate fluctuations can have a negative or positive effect on the returns generated.

Mr Thompson says the last and perhaps most talked about risk is counterparty risk.

He says: “Counterparty risk can be borne from the use of a swap or securities lending programme in the ETF.

“For a Synthetic ETF using a swap, it is with the investment bank who issues the swap. If the bank was to default, they would be unable to pay the performance of the index to the fund.

“As such, the value of the fund is based purely on the physical assets owned by the fund. This is why Ucits regulation states that an ETF can never be more than 10 per cent exposed to the swap counterparty.

“By that they mean that the difference in value of the ETF and the basket of assets it holds can never be more than 10 per cent.

“In the case of securities lending, the risk is that the hedge fund or financial institution is unable to give back the stock it borrows, and as such the fund falls back on the collateral that the borrower has put up as security.

“As long as the collateral is sufficiently liquid, and of sufficient value, there will be no loss to the ETF.”

Get under the bonnet

The key for both physical and synthetic ETFs, according to Mr Thompson, is for advisers to take the time to understand the policies.

If they stock lend, Mr Thompson says advisers should question who do they lend to, how much do they lend and what do they take as security?

For a Synthetic ETF, Mr Thompson says advisers should question what does the ETF hold as collateral, is it owned by the ETF or the investment bank, and what is the minimum value it can be?

Mr Thompson says a further point that advisers should be aware of is that many platforms aggregate ETF orders and trade only once a day.

He says this means that advisers cannot access the intraday liquidity, and the cost can be relatively high if you are the only one trading the ETF that day.