While exchange traded funds (ETFs) are rapidly growing in popularity, many Australians are still not familiar with their benefits. Less than 10% of money invested by Australians goes into ‘passive’ strategies (either index funds or ETFs) with most people still preferring to either invest directly into stocks or employ traditional “active” managed funds. Compared to Do-It-Yourself investing, ETFs can usually diversify a portfolio in a more cost effective manner. They also attract lower fees than most managed funds.

We’ve decided to bring it back to basics and explain what ETFs are and why they’ve taken off in the recent years, growing to $14 billion in funds under management as at November 2014 (up 40% in one year!)

ETFs explained

An exchange traded fund (or ETF) is an investment fund that is traded on Australian Securities Exchange (ASX).  It generally holds a wide range of investments which are representative of a particular asset class (e.g. Australian shares or bonds) and most track against an index (e.g. S&P/ASX 200). It gives investors access to a broad range of securities through a single trade.

Benefits

Low costs

ETFs generally have lower fees than other investment products because they are not actively managed and do have to pay for additional fund managers to try and beat the market. The reality is that majority of funds underperform the market return after you include their fees. 1 ETF also typically have lower marketing, distribution and accounting expenses plus lower portfolio turnover which helps to defer the payment of tax.

Diversification

ETFs provide a diversified investment to entire markets within an index. They do not have any over-concentration in one company or sector, as a result enabling easy access to a wide range of investments.

Potential tax efficiency

Because ETFs typically have low turnover of their portfolio securities, it helps minimise capital gains. While this is an advantage they share with other index funds, their tax efficiency is further enhanced because they do not have to sell securities to meet investor redemptions.

Transparency

Each ETF issuer provides daily information to the market including the ETF basket and Net Asset Value (NAV). They are also priced throughout the trading day.

Liquidity

Ability to buy and sell during ASX trading hours and at a price quoted on the ASX, unlike unlisted manage investment funds that can only be traded at one price per day.

It should be noted that along with the benefits, ETFs also carry risks like all investments. This includes market risk, currency risk and liquidity risk.

Growth of ETFs

In the aftermath of the global financial crisis (GFC), many investors are finding ETFs to be a compelling alter­native to higher cost managed investment funds. This is especially the case when you factor in that most actively managed funds had negative returns during this period but still charged their high fees.

ETF assets in Australia have steadily been increasing over the years and has more than doubled in 2012. The growth has continued in 2014 and has increased by $4.1 billion (40%) since the beginning of this year.

We believe they will continue to grow with many more Australians adopting low-fee ETFs within their investment portfolios and superannuation.

Stockspot has chosen ETFs as part of our portfolios because we believe that they provide clients with the best low-cost exposure to different asset classes and geographical regions. The also enable investors to reduce risk with diversifications, and their low-fees help to optimise investment returns.   This is backed-up a study by Gratten which shows that fees have the highest impact on the balance of investments. 2

About Stockspot

Stockspot is Australia’s first online investment adviser and fund manager. We can help you build and manage a diversified portfolio with over 1,400 global shares and bonds at a fraction of the cost charged by traditional advisers and funds. Our vision is to make professional investment services accessible to more Australians by offering a simple, transparent and convenient online service with low fees.