Exchange traded funds (ETFs) are a low-cost way to earn a return similar to an index or a commodity. They can also help to diversify your investments. You can buy and sell units in ETFs through a stockbroker, the same way you buy and sell shares.
How ETFs work
An ETF is a managed fund that you can buy or sell on an exchange, like the Australian Securities Exchange (ASX) or Cboe Australia (CXA).
When you invest in an ETF, you don't own the underlying investments. You own units in the ETF and the ETF provider owns the shares or assets.
ETF units can be created or redeemed to match investor demand. This helps the price of the units to stay close to the net asset value (NAV) of the ETF. This differs from shares in a company or units in a Listed Investment Trust, where the price fluctuates based on investor demand.
The ASX ETF investor course can help you learn more about how ETFs work.
Types of ETFs
Passively managed ETFs
In Australia, most ETFs are passive investments that don't try to outperform the market. The role of the fund manager of a passive investment is to track the value of:
- an index, for example the ASX200 or
- a specific commodity, such as gold
The value of the ETF goes up or down with the index or asset they're tracking.
Active ETFs and Hedge Funds
Exchange traded managed funds (also known as ‘Active ETFs’) and exchange traded hedge funds are actively managed investments. For these funds, investment managers may use high risk trading strategies to try to outperform an index.
Physically-backed and synthetic ETFs
ETFs can be either physically-backed or synthetic.
- Physically-backed ETF – invests in all the securities in the index or a sample of the securities in the index.
- Synthetic ETF – hold some of the underlying assets and use derivatives to copy the movements of an index or asset. This type of ETF may use the word 'synthetic' in its name. Synthetic ETFs have an additional risk that the counterparty to the derivative could fail.
What you can invest in through an ETF
ETFs are available for a range of asset classes and individual assets.
These include:
- Australian shares
- international shares
- sectors of the Australian or international share market, such as mining or financials
- fixed income investments like bonds
- precious metals and commodities
- foreign currencies
- crypto assets
- diversified across multiple asset classes
Visit the ASX or CXA websites for the ETFs you can invest in.
Pros and cons of investing in ETFs
Weigh up the pros and cons before you invest in ETFs.
Pros
- Diversification – ETFs allow you to buy a basket of shares or assets in a single trade. This can help to diversify within an asset class. ETFs also allow you to invest in markets or assets it can be difficult or expensive to access. You can also diversify across ETFs so there's less chance of loss if an ETF provider collapses.
- Transparency – ETFs publish the net asset value (NAV) daily. This can help you track how the underlying asset are performing and if the price of the ETF is close to the NAV. Most ETFs publish the list of assets owned by the fund, so you know exactly what the ETF is invested in.
- Low cost – a lot of ETFs have a low management expense ratio (MER). They're usually cheaper than equivalent managed funds.
- Easy to trade – you can buy and sell ETFs during the trading hours of the exchange, through a broker. You can typically buy smaller quantities of ETF units than unlisted managed funds.
Cons
- Market or sector risk – the market or sector the ETF is tracking could fall in value. For example, if the ASX200 declines, the value of your ETF investment will also fall.
- Currency risk – if the ETF invests in international assets, you face the risk of currency movements impacting your returns. Some ETFs are 'currency hedged' which removes this risk.
- Liquidity risk – some ETFs invest in assets that are not liquid, such as emerging market debt. This can make it difficult at times for the ETF provider to create or redeem securities.
- Tracking errors – an ETF's return may differ from the index or asset it's designed to track. This can be due to differences in the assets owned by the ETF and the index it is designed to track, fees, taxes and other factors. This means you could buy or sell when it's not trading at the indicative net asset value (iNAV).
How to buy and sell units in ETFs
You can buy and sell units in an ETF through a stockbroker. It's the same as buying and selling shares. You buy and sell at the market price at the time of the trade.
Settlement of trades takes place two business days after you buy or sell the ETF. You have to pay brokerage fees when you buy or sell an ETF.
You may also be able to buy and sell units in the ETF fund directly with the ETF provider. These transactions will occur at the end of the day with a price reflecting the NAV of the units.
Compare the price and NAV or iNAV
You can check if an ETF is fairly priced by comparing its price on the ASX or Cboe with the NAV or the indicative or intraday NAV (iNAV).
The NAV is calculated by taking the assets of the fund, subtracting the liabilities and dividing this by the number of units in the fund at the end of the day. The iNAV is a real-time estimate of the NAV, published during the day.
ETF providers give updates of the NAV:
- on the ASX at the end of the day
- generally on the ETF provider's website
The price to buy and sell an ETF should be close to the NAV per unit. But at times, such as on days with large changes in prices of the asset classes, the price of the ETF may move away from the NAV.
You can use the iNAV as a reference point during the day to understand if an ETF you're buying or selling is at, or close to, the NAV per unit. You can see the latest iNAV from your broker by adding 'Y' before the ETF ticker. For example 'YABCD' for the ETF ticker 'ABCD'.
When to buy and sell ETF units
To get an ETF price that is more likely to represent its underlying value, place your trades at least 30 minutes after the market opens.
It's also better to buy or sell ETFs when the market for the underlying asset is open. For example, if you're buying or selling an ETF that tracks Asian shares, place your orders when the Asian sharemarkets are open.
Check the product disclosure statement before you invest
A product disclosure statement (PDS) contains a lot of information you'll need to know about an ETF. It includes information on:
- what index, sector or asset the ETF returns aims to replicate
- the fees and costs
- how to buy or sell units in the ETF on market or, if allowed, directly with the ETF provider
- the risks of investing in the ETF
- how to complain if you have a problem with the ETF
If you have questions about an ETF you can contact the fund manager or get financial advice. You can also check recent market announcements for new information on an ETF.
In the world of finance, Exchange Traded Funds (ETFs) stand out as a versatile and cost-effective investment tool. As someone deeply entrenched in the intricacies of financial markets, I can attest to the power of ETFs in providing investors with exposure to a diverse range of assets. Let's delve into the core concepts covered in the article you provided:
How ETFs Work
When you invest in an ETF, you're essentially buying units of a managed fund traded on an exchange. Unlike traditional investments, you don't directly own the underlying assets; instead, you own units in the ETF. The ETF provider manages the assets on your behalf, aiming to keep the price of the units close to the Net Asset Value (NAV) of the ETF. This is achieved through the creation or redemption of units based on investor demand, ensuring a balance between supply and demand.
Types of ETFs
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Passively Managed ETFs: These track the performance of a specific index or commodity, such as the ASX200 or gold, without actively trying to outperform the market.
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Active ETFs and Hedge Funds: These are actively managed investments where fund managers employ high-risk trading strategies to outperform an index.
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Physically-backed and Synthetic ETFs:
- Physically-backed ETFs: Invest in all or a sample of the securities in the index.
- Synthetic ETFs: Hold some underlying assets and use derivatives to mimic index movements, introducing additional counterparty risk.
Investment Options
ETFs cover a broad spectrum of asset classes and individual assets, including:
- Australian and international shares
- Sectors like mining or finance
- Fixed income investments (bonds)
- Precious metals, commodities
- Foreign currencies
- Cryptocurrencies
Pros and Cons
Pros:
- Diversification: ETFs enable investors to diversify their portfolios easily.
- Transparency: Daily publication of NAV helps investors track underlying asset performance.
- Low Cost: ETFs often have lower management fees compared to equivalent managed funds.
- Easy to Trade: Buying and selling ETFs is akin to trading shares and can be done during exchange trading hours.
Cons:
- Market Risk: ETF value is influenced by market or sector fluctuations.
- Currency Risk: International investments expose investors to currency movements.
- Liquidity Risk: Some ETFs invest in illiquid assets, posing challenges for creation or redemption.
- Tracking Errors: Deviation in returns from the index due to various factors.
Buying and Selling ETFs
You can trade ETF units through a stockbroker, similar to buying and selling shares. Settlement occurs two business days after the trade, and brokerage fees apply. Additionally, you may transact directly with the ETF provider.
Pricing and NAV
Comparing the ETF price with the NAV or iNAV helps gauge its fairness. NAV is calculated daily, while iNAV is a real-time estimate. The price should generally align with the NAV, but deviations may occur, especially during volatile market conditions.
Timing Your Trades
For a more accurate representation of an ETF's value, consider placing trades at least 30 minutes after the market opens. It's advisable to trade when the market for the underlying asset is open.
Due Diligence with PDS
Before investing, review the Product Disclosure Statement (PDS) for crucial information on the ETF, including its objectives, fees, and associated risks. This document guides you on how to buy or sell units, and it also serves as a reference for complaint procedures.
Navigating the world of ETFs requires a keen understanding of these concepts, and by doing so, investors can make informed decisions to enhance their financial portfolios.
