4 Questions to ask yourself when comparing ETFs

KANISH CHUGH
How do you choose an ETF? What are the best ETFs on the ASX? Are questions we often hear. These questions can never be perfectly answered, as the best ETFs for any investor will depend on their goals and risk tolerance.

Still, there are some general rules that investors should follow when comparing ETFs. Here are four questions you can ask yourself when deciding on an ETF to invest in:

  • What assets does this ETF hold?
  • How is this ETF structured?
  • Is this ETF liquid?
  • What are the ETF’s fees?

1. What assets does this ETF hold?

ETFs can own many different assets: global shares, Australian shares, bonds, precious metals—and more. Some ETFs can even own multiple types of assets—what are called “multi-asset ETFs”—which blend bonds and shares together.

Different assets come with different levels of risk and potential return. Shares are riskier but have historically produced the best returns. Bonds and gold are less risky but have historically produced lower returns.

Risks in investing
Source: Moneysmart, ETF Securities, 25 May 2021

ETFs take different approaches to buying shares and bonds. Some global shares ETFs will only buy US or Chinese shares. Others may focus on specific economic sectors, like robotics, lithium miners, or biotech, believing they offer opportunity.

Something similar is true for bonds and commodities. Some bond ETFs buy a broad basket of global bonds. While others focus on segments of the Australian bond market. Most commodity ETFs focus on gold. But some hold other precious metals, like silver, platinum and palladium.


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2. How is this ETF structured?

ETFs come in many different structures, with important differences. Most ETFs are Australian-domiciled funds, that hold their assets in Australia, although this is not always the case. Some global shares ETFs are not locally domiciled ETFs. Instead, they are feeder funds that buy into US-domiciled ETFs. These feeder funds have the advantages of coming at lower fees, as they are cheaper for ETF providers to make. However, they can have tax weaknesses as US-domiciled funds must pay US taxes.

There are also important differences between actively managed versus passive ETFs. Most ETFs are passive. This means they follow an index – like the ASX 200 or S&P 500 – and do so transparently and at low cost. But some ETFs are actively managed and more like traditional managed funds. Active ETFs do not follow an index. Instead they have portfolio managers making their investment decisions. What’s more, they are typically opaque and charge higher fees (discussed below).

3. Is this ETF liquid?

Liquidity is the ability to get in and out of an ETF. The more liquid an ETF, the easier, cheaper, and faster it is to come and go. When choosing an ETF, liquidity is therefore a consideration.

The liquidity of an ETF is measured through its buy-sell spreads – which is the gap between buyers (”bid”) and sellers (“ask”). The smaller this gap, the more liquid an ETF is, and the less it may cost investors to come and go.

4. What are the ETF’s fees?

Fees are always an important consideration for ETFs. As a general rule, the lower the better, but there are more to ETF fees than meets the eye.

Like other products in our economy – be it shoes, phones, or cars – the cost (fee) of an ETF is largely a function of input costs. When input costs are higher, products become more expensive. Input costs for ETFs include exchange fees, index licensing fees, custody fees – and others. These variable input costs explain why some ETFs – like commodities and emerging markets ETFs – charge higher fees.

However investors should beware that actively managed ETFs charge much higher fees. On average, our analysis finds, active ETFs charge more than double what passive ETFs charge. In addition to their higher management fees, they also charge an additional layer of performance fees.


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So, which ETF is right for you?

At the end of the day, choosing an ETF is a personal decision. The best ETF for any investor is ultimately up to them, based on their personal views, goals, and risk tolerance.


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