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Ins and Outs of Exchange Traded funds

Exchange traded funds seem to be everywhere at the moment.  In fact, the ETF market in Australia has grown rapidly over the last four years – the ETF market by market capitalisation in Australia has grown by 37%.  So what are they and how do they work?

Essentially, an ETF is a cross between an index managed fund and a direct share.  It is a passive type of investment fund (a portfolio of stocks), tracking an index, that can be bought and sold on a securities exchange.  So they have the diversity and low cost benefits of an index managed fund, but the liquidity and trading flexibility of direct shares.

ETFs provide investment exposure to anything from an entire market (eg S&P/ASX200) or a specific sector.  So, again, like an index managed fund, if you invest in an ETF that tracks the S&P/ASX200, you are virtually purchasing a small number of shares in each of the top 200 companies traded on the Australian Stock Exchange.  Keep in mind, ETFs still mean you own shares in the fund, not the underlying stocks owned by the fund.

The most significant benefit of an ETF is its low cost.  Because ETF’s are passive and simply track an index, they have lower fees associated with running the fund – just like an index managed fund.  Liquidity is the other significant benefit of an ETF.

So ETF or managed fund?

Generally ETF’s are suited to individuals who:

– have an ASX broker account, given you require a brokerage account to buy and sell ETFs.  Hudson can provide access to ETFs via administration platforms, however, conditions apply*.  An index managed fund would suffice for the broad majority of investors.

– make large or irregular payments, given brokerage fees apply when buying and selling ETFs on the sharemarket.  If investors wish to make regular contributions, an index managed fund would be more suitable.

– require trading flexibility, if this is important.  If not, again, a simple index managed fund may be preferable.

There is a lot of merit in using passive investment strategies as a core part of any portfolio structure, particularly as active managers can often underperform or hug a benchmark (or index) despite costing a lot more in ongoing fees.  However, investors need both passive and active approaches in their portfolios to meet their goals, so it is not simply a matter of passive versus active.

*administration platforms come with additional costs, so access to these will only be suitable for investors with higher amounts to invest for feasibility.  

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