Exchange Traded Fund (ETF)
What is an Exchange Traded Fund?
An exchange traded fund (ETF) is another version of a collective investment fund where assets from retail (i.e. the public) investors are pooled together and invested by a professional fund manager on their behalf.
They are generally passively managed, low cost, index tracking funds that are avilable to buy and sell on an exchange just like shares.
They are relatively new to the UK market having only been around for the last ten years or so, although they originated in America some time before that in 1989. However their popularity in the UK has increased significantly given their obvious benefits to investors.
Perhaps the most well known brand of ETFs in the UK is the Barclays iShares range of ETFs, which was sold by Barclays for around £3bn to generate revenue during the recession in 2009.
Types of ETF...
Index - just like other index tracking funds they will attempt to track the performance of an index. There are many different ETFs that track various indices from around the globe. The index ETF is by far the most common type of ETF.
Sector - some ETFs will track a specific sector such as Financial Services, Food & Beverages, and Retail.
Style - some ETFs will aim to track certain investment styles, such as smaller companies, growth or value investing.
Commodity - sometimes referred to as an Exchange Traded Commodity, or ETC. As the name suggests they track commodity indices around the world and therefore make it easy for investors to have an interest in commodities such as gold and oil.
Bond - these provide a cheaper way of holding a traditional bond fund, and may invest in corporate or government bonds.
Hedge Fund - these try to mirror the performance of hedge fund indices by tracking different core hedge fund strategies. They provide a real and lower cost alternative to actual hedge funds, and are more accessible.
Leveraged - these funds are much higher risk than normal ETFs as they use futures contracts to exaggerate the returns offered by the market. They are often marketed as bull or bear funds.
Advantages of ETFs...
The best of both worlds - in effect an ETF is an attractive combination of a unit trust and a share, where it has the investment benefits of a fund and can be traded at a certain price through the day just like any other listed shares.
Low cost - ETFs have traditionally been index funds that follow passive investment strategies to mirror the performance of a certain index such as the FTSE 100. Index tracking funds are well known to be low cost funds with no inital charge and very low annual management charges, in comparison to actively managed funds.
Certainty - on top of that is the benefit of having a single trading price that changes throughout the day, which means they can be bought at a price that is known to the investor. Unit trusts are bought on what is called a forward pricing basis, which means the investor does not know the price at which they will buy their units when they make their purchase. The purchase price for unit trusts is set at the next pricing point, usually at the end of the day, or even the next day.
Flexibility - Shares in ETFs are easy to buy and sell and can be treated in the same way as normal company shares.
Choice - because there are ETFs that specialise in many different sectors, geographical regions, and investment types, private investors can now easily put together their own portfolio of diversified invstments at low cost. Furthermore, investors that have otherwise been restricted to a small range of investments can now invest in assets such as gold and oil, or currencies. Something that was not immediately available to them before.
Where can I buy ETFs?
You can buy ETFs online using your ISA, Personal Pension, SIPP or normal trading account through our Free Range Portfolio service.
Once you've opened an account it's easy to start trading online and to build up a well balanced portfolio of ETFs yourself.
