ETFs and how to use them

November 2016

An easy way to invest in international shares, currencies and commodities.

As local investors look to diversify into new markets, exchange traded funds are gaining interest. By Eva Diaz.

Choosing the right assets to grow your investments is always a challenge. The up and down nature of markets means investors could be constantly trying to pick when prices are at their top or bottom, and there are plenty of fees to pay in such rapid trading.

Another trick, when investors go it alone, is to misjudge the market and end up holding on to a losing investment for too long or selling a winning investment too early.

Instead of constantly trying to pick the best stock or when a market hits top or bottom, investors can invest in exchange-traded funds (ETFs). These are funds listed on the sharemarket that follow the price of a select group of shares, known as an index, such as the S&P/ASX 200 index (the biggest 200 companies on the Australian Stock Exchange).  An ETF can follow commodities such as oil, gold and other precious metals, or a selection of them. Unlike managed funds that are actively managed and try to outperform an index or class of asset, an ETF simply tracks its performance.

“Purchasing one unit of an ETF can, for example, provide exposure to the largest 100 companies by market cap on the ASX” says ANZ ETFS Management business development manager Kanish Chugh.

Different ETFs for different objectives

While for most people the ultimate aim of investing is to grow one’s wealth, investment strategies may vary from one investor to another depending on preferences and investment personality.

Some investors prefer to invest in assets (e.g. shares) and markets that they know. If you are this type of investor, then you can invest in ETFs specifically for Australian shares. ANZ has recently introduced a number of ETFs including the S&P/ASX 100 Index and the S&P/ASX 300 Shareholder Yield Index, which track the performance of indices.

There are also ETFs for investors who like international markets such as the US, Europe and Asia.

Famed US investor Warren Buffett has endorsed such index-fund investing in a letter to shareholders of his company Berkshire Hathaway. He wrote of his belief that investing 90 per cent in a very low-cost S&P 500 index fund and 10 per cent in short-term government bonds would deliver superior returns than those attained by other investors who employ high-fee managers.

Access to various markets and assets

“One of the immediate benefits of an ETF is it allows investors to reach and invest in hard-to-reach markets like the US, Europe, Britain and assets such as currencies and commodities. Previously, some of these markets were only available to wholesale investors [a different class of investor], but with ETFs these markets are much more accessible to individual investors” Chugh says.

Investors wanting exposure to international markets can buy ETFs that track investment areas in those regions. For example, an Australian investor can take advantage of the potential growth in US stocks by buying an ETF based on the S&P 500 low-volatility high dividend index, such as the ANZ ETFS S&P 500 high yield low volatility ETF.

An investor seeking access to global foreign exchange/currency markets can invest in ETFs that follow the US dollar or the renminbi (Chinese yuan). Using ETFs based on currencies, an investor can gain access to this very active market without setting up a separate foreign-currency account or pay fees and charges associated with this.

For investors wanting exposure to commodities, there are also physical gold ETFs that provide exposure to the gold bullion price. By investing in ETFs based on commodities, investors can avoid stock-specific risk that could at times affect the share price. Instead, the commodity ETF provides exposure to the price of the commodities it is based on, e.g. oil.

“When it comes to cost, ETFs are highly transparent and low cost compared to listed investment companies or managed funds. We know that cost is a big issue with investors, and by using ETFs they can readily lower the cost of investing,” says Chugh.

Risks in using ETFs

Like other investment instruments, ETFs carry risks and rewards. Some of the risks involved when investing in ETFs are:

  • the market – because ETFs track the price movement of their underlying asset (whether it is shares, commodities or a currency index) the price of an ETF will also rise and fall
  • counterparty – unlike shares directly issued by listed companies, ETFs are issued by different financial institutions including investment banks and trading companies: investors should deal only with reliable ETF issuers with solid financial backing and good track record in the markets
  • shutdown – while new ETFs can be introduced in the market at any time (there are almost 100 ETFs listed in the Australian Stock Exchange and this number is still growing),ETFs can be delisted for various reasons.