Exchange-Traded Funds

What Are ETFs?

ETFs are essentially index funds that passively track a basket of stocks from a country or region's sharemarket index, with the aim of replicating that index's performance. An ETF is a listed financial product that can be bought or sold on the stock exchange in the same way as you would shares.

ETFs offer an alternative to managed funds, which are unlisted products where you buy and sell units from a fund manager.

Unlike many unlisted managed funds, ETFs do not pay upfront or ongoing commissions.

How Do They Work?

The share price for an ETF is based on the net asset value (or NAV) of the underlying stocks the ETF tracks. An ETF typically trades at prices that match this NAV closely.

How Many Are Available?

Four groups of ETFs are currently available in Australia.

• The first are those which track segments of the local sharemarket.
• The second group are developed world market indices, such as the S&P500 Index of the biggest US companies, or the Russell 2000 Index of the smallest.
• The third group are the ETFs which provide exposure to a number of developed and developing Asian markets. Offering exposure to the Taiwanese, South Korean, Hong Kong, and Singaporean sharemarkets, as well as a China option (iShares FTSE/Xinhua China 25), which tracks the 25 largest companies on the Chinese sharemarket available to international investors.
• The fourth group is the newest, and provides exposure to a single commodity or a basket of commodities. ETF Securities offers five ETFs which track prices for precious metals like silver, palladium, and gold, and also offers a basket of precious metals.

What are the advantages

ETFs offer ultra-low ongoing costs compared to traditional unlisted managed funds. Relatively few low-cost index international share managed funds are available in Australia.

ETFs make it easy to add exposure to a market segment, country, or region to an existing investment portfolio.

ETFs are also highly-transparent investment vehicles compared to traditional unlisted managed funds. It's easy to see through to the ETF's underlying stockholdings. For example the top ten holdings in the SPDR S&P/ASX50 Fund are made up as follows:

SPDR S&P/ASX 50 Fund	As of 29-Sep-2009
Issue Name	Sector Classification	% of Total Assets
BH Billiton Ltd	Materials	13.86
CBA	Financials	8.60
Westpac	Financials	8.45
NAB	Financials	7.11
ANZ Bank	Financials	6.73
Telstra Corp Ltd	Telecommunications	3.94
Woolworths Ltd	Consumer Staples	3.92
Wesfarmers Ltd	Consumer Staples	3.32
Westfield Group	Financials	3.24
Rio Tinto Limited	Materials	2.81

ETFs are low-turnover investments, especially in comparison to many actively-managed domestic share funds. The basket of stocks the ETF tracks only changes when companies are added to or removed from the underlying index, unlike actively-managed funds, where the fund manager buys and sells stocks regularly. This low turnover means that an ETF is less likely to generate high levels of realised capital gains.

Unlike traditional managed funds, which generally have to keep a small amount invested in liquid assets such as cash to fund investor redemptions, ETFs as exchange-traded products have no need to hold cash, and can therefore be fully-invested. In the same way, ETFs have the advantage of not having to sell assets to pay out redemptions, unlike managed funds, where forced sales of assets in falling markets can reduce the value of an investment in the fund.

Disadvantages

Like index managed funds, ETFs do not offer the potential for above-market value-add which comes with investing in an actively-managed share portfolio. Tracking a market index also means that ETFs don't have the potential to minimise the effects of market downturns.

Liquidity is another important issue to consider when thinking about investing in ETFs. Although ETFs do provide the convenience and flexibility of trading on the stock exchange, the flipside is that an ETF's price is determined by market supply and demand. Like shares, you can track the price throughout the day, and you can leave orders to buy or sell an ETF at a specified price. But if the market doesn't have reasonable liquidity - enough people wanting to buy or sell - then you may not be able to trade at the price you want.

In summary ETF’s allow investors access to a wide spread of investments both locally and overseas while they build up their portfolio to a level that makes investing directly into shares more economical.

Growth Plus Wealth Management is the financial planning arm of Allworths. If you would like us to review your investment strategy advise on wealth management strategies or life insurance matters please do not hesiate to contact us on 02 9264 6733 or email info@growthpluswealth.com.au.

DISCLAIMER :
Any general advice in this letter does not take account of your personal objectives, financial situation and needs. Read the relevant Product Disclosure Statement before acquiring any product mentioned in this letter.