CANSTAR Guide: Exchange Traded Funds (ETFs)
03 June 2016
What should you look for in an exchange traded fund (ETF)? CANSTAR’s industry insights into ETFs and case studies on the needs of investors.
What is an ETF?
Exchange-traded funds (ETFs) are a form of investment option that trade like direct shares but look like a managed fund. The ETF pools your money with that of other investors to invest in a widely diversified portfolio and return dividends to you. This offers the ability to diversify over an entire sector or market segment – potentially hundreds of companies – with just a single investment in one ETF product.
The sales and purchases within this investment are overseen by a professional fund manager, but it is less expensive in terms of management fees than a managed fund is. This is because ETFs are passively managed by tracking an index such as the ASX 200, whereas managed funds are actively managed and aim to beat the benchmarks of an index.
Exchange-traded funds work by tracking the yield and return of indexes such as the NASDAQ-100 Index, S&P 500, and Dow Jones. What this means is that if you, for example, buy into an ETF that tracks the S&P/ASX 200, you are effectively purchasing a small number of shares in each of the top 200 companies traded on the Australian Stock Exchange. An ETF that tracks a particular sector such as the energy index would let you effectively hold a small part of each of the component energy-related companies.
ETF products are listed on the ASX, making them easy to buy and sell through a stockbroker or through your own online trading account. This is a highly liquid type of investment. It is also fairly tax-efficient because you own shares in the ETF rather than directly owning the shares or other assets being traded by the fund.
It is worth noting that there have been several new ETFs launched in recent times which are moving away from an index approach, but they are an exception to the traditional rule.
CANSTAR’s ratings show which ETFs offers outstanding value, across investments in Australian shares, commodities, international shares, and fixed income and cash.
ETFs are considered by ASIC to be complex financial products. Some are more complex and risky than others. For more information on ETFs and risks associated with them, see ASIC’s Moneysmart website at https://www.moneysmart.gov.au/investing/complex-investments/exchange-traded-products
What to look for in an ETF
We research many providers of ETFs, which are listed across three broad categories and several sub-categories:
- Australian ETFs: Australian Broad Based, Australian Sector, Australian Strategy Based
- International ETFs: International Broad Based, International Sector
- Other ETFs: Currency, Fixed Income and Cash, Commodities
Who are you?
ETFs may be on the consideration list of investors looking for a low-cost product with broad diversification. ETFs might also be a consideration for those with an SMSF superannuation arrangement.
Before choosing an investment fund, you should know what your risk profile is. There are a variety of different funds to suit investors’ varying levels of risk tolerance. Broadly speaking, there are four common risk profiles:
- Conservative: Investors who aren’t willing to risk their accumulated wealth and are happy to accept small but stable returns.
- Balanced: Those seeking higher returns than conservative investors but only willing to risk falls of as much as 5-10%.
- Growth: Investors who want growth of around 8-10% per year over the long term and are willing to accept the risk of falls of up to 20% in one year.
- High Growth/Aggressive: An investor with plenty of time on their side to ride out periods of downturn. Seeking average long-term growth of over 10% per year and willing to accept the risk of falls of over 20% in one year.
Your risk profile will largely determine the asset classes you choose to invest in, either within or outside an ETF, from shares to property, bonds to cash. Different mixes of the assets carry varying levels of investment risk.
You will also need to ask yourself what your stance on ethical or responsible investment is. Are you worried about what companies your ETF invests in on your behalf? Choosing ethical investments is a growing trend, with more investors wanting to make sure their money is not funding activities that go against their personal values. Ethical investment funds can “screen in” companies that actively invest in sustainable activities like healthcare or green energy, and “screen out” companies that invest in world-damaging activities like coal seam gas, tobacco production, slave labour, or forest logging.
Case Study
Greg has been regularly saving into an account that has accumulated a little over $50,000. He doesn’t need the money in the short-term, so he is interested in trying to achieve higher returns through the stock market.
He has decided that he wants to look for an ETF that does not trade heavily in commodities, emerging markets, or other volatile markets.
Having heard a lot about slave labour and the dreadful working conditions in many factories, Greg wants to make sure he doesn’t end up investing in companies that exploit their workers. He begins looking for an ETF with an ethical investment portfolio.
Using the CANSTAR website, Greg compares ETFs and checks the MER% fees charged on a few ethical investment options before choosing one that offers annual distributions.
Please note that any advice on this page is general and has not taken into account your objectives, financial situation or needs. Consider whether this advice is right for you. Consider the product disclosure statement and seek advice from a licensed financial adviser before making an investment decision. See our detailed disclosure.
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