How to find the right ETFs to invest in

Given the growth in the number of exchange-traded funds (ETFs) available in recent years, the process of selecting an appropriate ETF can be time-consuming and seem overwhelming.

When you’re evaluating an ETF, and whether it may meet your needs and objectives, there are many factors to consider, including the index the fund aims to track, the asset class, country, sector, theme or investment strategy the ETF offers exposure to, and the ETF’s structure, costs and underlying holdings.

Here, we take a look at some of these important considerations when analysing different ETFs and trying to narrow down your investment choice.

Could ETFs be right for you?

ETFs are generally an easily accessible and low-cost way to build an investment portfolio, which can make them suitable for either beginners or experienced investors, and for an array of investing strategies.

ETFs are managed investment funds which can be bought and sold on the ASX just like shares. For the investor just starting out, they make it possible to gain diversified exposure to a range of asset classes, including shares, fixed income and commodities, both in Australia and internationally, without having to commit a substantial amount of money.

Whether an investor’s strategy is time-based or goal-based, ETFs can be a good way to gain exposure to either growth, income or defensive investments, or for tactical exposure to a particular thematic, region, country, currency and more.

How do you choose what type of ETF to purchase?

What’s the best way to zero in on the right ETF for you?

Consider your investment strategy

When choosing an ETF, it is helpful to first think about your circumstances, including your objectives, time horizon and risk tolerance.

For example, are you investing for long-term growth, for income, or to gain exposure to a particular asset class, sector, region, country or thematic?

Consider the asset class

Pick your asset class based on your investment strategy.

For example, ETFs can offer diversified exposure to a portfolio of Australian equities or international equities for growth, while investors seeking income traditionally have turned to fixed income ETFs, providing access to bonds, or to high-yielding equities ETFs.

Other ETFs provide exposure to commodities, currency or hybrid securities.

You can even invest in a multi-asset, all-in-one diversified ETF, which takes care of the asset allocation decisions for you.

Understand the fund and the index which the ETF aims to track

Once you have narrowed down your investment focus and your asset class, it’s important to understand the fund and (where applicable) the index which the ETF aims to track.

For example, two ETFs that focus on the same sector and have similar names can have completely different underlying holdings if the indexes they track are constructed differently. This can result in significantly different risk/return profiles.

It’s important to look under the hood of each ETF to see what the fund owns, how the holdings are weighted and how diversified the portfolio is.

Some key considerations:

• What is the fund’s investment objective?
• Is it a passive or actively managed strategy?
• If the ETF aims to track an index, what is the index methodology i.e. weighted by market capitalisation, fundamentally weighted, equal-weighted, or rules-based?

It’s helpful also to consider whether you want broad exposure, or if you’re looking for exposure to a certain market segment. You should consider the countries, regions or sectors an equity ETF offers exposure to and check the concentration of the ETF’s holdings with regard to these factors.

For example, due to the current composition of the S&P/ASX 200, any fund that aims to track this index will be heavily weighted towards the financial and resources sectors, compared to, for example, the Nasdaq-100, which has a significant allocation to information technology.

If you are looking for exposure to a specific industry sector, or an investment theme, rather than a broader exposure, there are ETFs that aim to track a benchmark index for a particular sector, for example, financial services, healthcare, or energy, or themes such as cloud computing, cybersecurity or robotics and artificial intelligence.

Compare Exchange Traded Funds

Tips to compare similar ETFs

When choosing between ETFs in a similar category – or similar ETFs across different issuers – here are some other considerations:

Holdings

• What are the fund’s top holdings?
• Does the ETF report holdings daily, or less frequently (which typically is the case for actively managed funds)?

Fees and costs

• What are the management costs of the ETF?
• Are there any taxation considerations (e.g. capital gains) that need to be taken into account?
• What is the ETF’s true cost of ownership, taking into account bid-offer spreads, brokerage costs and transaction other costs?

Tracking error

• For an ETF that aims to track an underlying index, how closely has the ETF tracked the performance of the index (i.e. have there been any material tracking errors)?

Distribution yield and/or franking

• Does the ETF pay distributions?
• Do you prefer to take your distributions in cash, or reinvest them in the ETF by participating in a distribution reinvestment plan (DRP), if available?

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