Navigating the plethora of available investment options can be tricky and with access to new markets opening up, choosing the best way to find alpha, decrease risk or diversify is difficult. Exchange traded funds (ETFs) may be a useful tool for some investors.
Firstly though it’s important to note that 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.
What are ETFs?
ETFs are similar to managed funds but are bought and sold via a stock exchange. They have comparatively low fees and have no minimum initial investment or minimum top up amounts. You are able to buy as little as one share at a time. ETFs are usually set up to track an index, a commodity or basket of assets. There are currently over 150 ETFs available through the Australian Stock Exchange (ASX) with the number growing every year.
Here are three ways that ETFs can be used by some investors to increase the diversity of a portfolio.
1. To invest in other economies
Many investors do not wish to expand their portfolio beyond Australia, but for those who want to manage geographic risk via international investment, ETFs can provide access to both developed and developing international economies.
Many Australian investors have a portfolio overweight in Australian risk. As an example, a typical SMSF may have an investment property within Australia as its main going concern with the remaining funds in Australian equities. While many investors deliberately choose this geographically-concentrated strategy, it does carry associated risk if the domestic economy suffers a downturn.
Some investors choose to manage this geographic risk by utilising index ETFs of other major economies around the world. There are more than two dozen international ETFs listed on the ASX that track broad indexes such as the S&P 500 or the MSCI Global Equity Indexes, groups of countries such as Europe or Emerging Markets or a number of specific country indexes such as MSCI Hong Kong. Some investors conclude that investing in one of these may help ride out the waves in the Australian market.
2. To invest in other asset classes
Cash, property and equities are the dominant investment vehicles in Australia. This is for many reasons including ease of access, familiarity and historical performance. Putting cash aside, one problem that can arise is that property and equities will often move in the same direction. If property prices go up, so do equities and vice versa. Commodity-focused ETFs can help some investors to offset these fluctuations by choosing commodities that run on a different cycle or have long term growth potential that is not directly linked to the Australian economy.
While the list is a lot shorter, there are a number of commodity-based ETFs available to investors. These include investment options in gold bullion, agriculture, crude oil, energy and more. These commodity options do have a slightly higher MER than other ETFs.
3. To invest in the bears
Another potential investment strategy utilised by some is investing in the bears. What does that mean? Well, just as being “bullish” about a certain market means feeling quite positive about the future performance, being “bearish” means taking a rather contrarian view.
Professional investors and fund managers have a number of products available to them to make money while the market falls. Having a portion of a portfolio invested in a bear fund can help to provide a partial buffer against falls in the equity market. In a prolonged negative market it can provide enough relief to give investors the time to determine a buy/sell strategy on the way down.
Investors should always be confident with the investment choices they make. The ASX has some useful general information on ETFs, as does our Canstar ETF page. Remember, it’s crucial to seek professional financial advice before making any investment decisions, and it’s important to manage both risk and return in your portfolio.