Exchange Traded Fund (ETF) | Tips To Choose Right ETF’s
Exchange Traded Funds (ETF)
An ETF, or Exchange Traded Fund, is a basket of different assets that are more or less traded like any other individual stock through some brokerage firm. Exchange Traded Funds are index that work like a stock, devised to match and track the components of a market index. ETF funds can be bought or sold all day long which means that the price of ETF funds continue to change throughout the day. There is no minimum requirement when it comes to buying ETF funds.
Individual investors mostly invest in ETF funds in their portfolio as sole focus, which helps them to build a diversified portfolio. However, most investment fund managers use ETF funds to complement their portfolio and to implement the investment strategies by relying on the ETFs.
In order to benefit from the ETF, it is important to understand them. Fortunately understanding ETF is not extremely difficult thing to do since they are very straightforward.
ETF looks similar to mutual funds and acts like any Stock on the Stock Exchange. The performance of the ETF funds tracks an underlying index. The ETF is basically designed to replicate underlying index.
The ETF provides a broader market exposure along with low operating costs. Another very useful aspect of ETF is low portfolio turnover. As compared to the index funds, the ETFs are mostly much cheaper and they also provide you with ease in terms of taxes.
ETF has gained popularity and recognition in past few decades. However, despite the prominent growth and popularity, questions like “why to invest in ETF” crosses investors mind every once in a while.
There are a lot of reasons that makes ETF perfect choice for a lot of investors; some of them are as follow:
- The price point when compared with index or mutual funds is a biggest plus for the ETF funds. ETF funds do not man-aged the way mutual funds do, which is why you will end up paying less fees.
- Tax efficiency is also a very important point that is in favor of investing in ETF funds. There are only handfuls of taxable events with the ETF funds. There is less number of transactions as compare to mutual funds. The fewer transactions mean that you will have to pay less tax, which means that you will be saving money.
- With an ETF, there is hardly any type of surprises. You know what you are getting into. Since the price of ETF fluctuates all day long, this is the reason that you know ETF’s price. You do not have to wait like you do with mutual funds to know the price at the end of the day.
Reason Behind Growth Of ETFs
The reason why ETF’s are more attractive to the investors is that the Cost, one would find several good ETF’s with very low fees as compared to the other mutual funds. Furthermore, ETF’s are also good option to go with when it comes to handling the Tax Times.
The manager of the ETF does not feel the need to buy and sell the stocks constantly until and unless a situation occurs where a component of underlying index which the ETF is actually trying to track has changed.
Thirdly, ETF’s provide an investor with Ease & Diversification as it provides an effective way to invest in distinct parts and the bond market which includes energy or emerging markets, etc.
Fourthly, you can call the ETF’s as an Open Book since they track an index so you would normally know exactly what’s inside it.
Lastly, just like any other stock, ETF’s can be bought or sold at any time during the day. However, opposed to these, mutual funds are priced only once at the end of each trading day which represents the User Friendliness of these funds.
Types Of ETFs
Actively managed ETFs
The type of ETFs that are managed in a way to meet certain investment objectives are known as actively managed ETFs. The assets within ETFs are actively managed by portfolio managers in order to achieve that investment object. This type of ETFs represents a very small part of the industry.
Currency & Commodity ETFs
The ETFs that invest in currency market and commodities through future market or physical assets are known as Currency and Commodity ETFs. These ETFs allows the investors to gain some exposure to the alternative investments which includes precious metals, agricultural products, currencies and energy.
These types of ETFs use debt and financial derivatives when it comes to improving upon returns of the underlying indexes. These ETFs attempts to get twice or sometimes even thrice times daily return of the underlying benchmark.
The inverse ETFs uses derivatives in order to gain profit from the decrease in value of an investment or underlying asset. The Inverse ETFS are designed in way that they move in opposite direction from market that they are making efforts to mirror. These ETFs are popular among the traders who are looking for the short term trading.
One of the most famous types of ETFs today is the Index ETF. An index ETF tracks down performance of an index. The performance is tracked by having a small sample of the securities that is used to make up index or by including the shrinking of the contents of index. Representative and Replication are the types of Index Funds.
Commodity ETFs or ETCs:
The ETFs that invest in the commodities which include silver, gold and other metals are the Commodity ETFs. Tracking down the history, the first Commodity ETFs were in the form of gold exchange traded funds. However, these are the index funds that track non-security indices. Previously, Commodity ETFs had physical commodity, however, today they implement future trading strategy.
ETFs that usually invest in different bonds are known as Bond ETFs. During the recession of stock market, the bond ETFs are the one that goes high on demand. Bond ETFs gives good yield unless they are bought or sold by the third party.
The Long ETFs as the name says, take ‘Long position” on underlying index. Typically, they own some shares of the companies in some specific index. In case there is some increase in the index, the share prices in the long ETFs also rises equally, excluding the trading costs and expenses.
The ETFs that invest in a sample of the gold stock or holds claim on the actual gold that is held in trust by some custodian are known as Gold ETFs. Typically, the shares in the gold ETFs move in a rough cycle with the gold prices. Gold is not the only thing you can focus on, there are some ETFs that emphasis on other precious metals
The stock ETF is more or less traded same as any normal stock is traded, however unlike mutual funds; Stock ETF’s prices continue to adjust all day long. Stock ETF is a blend of the stocks that are in similar industry which includes energy, but is capable of covering an index of the equities as well. Stock ETF is a best option to go with for investors who aim to gain some exposure to equities. Stock ETFs can be treated just like any normal stock.
The marketplace for ETF is fairly active which means that it is ever-growing and highly competitive. There are five firms that are considered to be big names when it comes to ETF providers. Each of these firms brings advantages to table which is the reason behind their massive success:
One of the famous ETF providers Lyxor has been extremely active when it comes to launching new products across the wide range of the asset classes. Their major focus was on the country exposure in the emerging markets of equity.
Lyxor was also in limelight for making a huge commitment to the fundamental indexation through launch of almost four ETfs that were link to FTSE RAFI index.
If compared with iShares, Lyxor do have an overlap of direct product in the traditional coverage of equity index. However, Lyxor’s version is cheaper as compared to what iShare offers.
With Lyxor and iShare claiming three quarter of total ETF market of Europe, it is solely up to the upcoming competitors to bring something innovative while trying to gain the market share.
Talking about the most dominating ETF provider, iShare is the one to watch. iShare has over 500 funds and 275 ETFs within U.S., and over $645 billion assets that are under management.
ETFs by iShare are mostly built around some very famous index providers which includes Barclays Capital, Dow Jones, Cohen & Steers, Markit Indices, FTSE, Dow Jones, JP Morgan, Nasdaq, MSCI, Russel, Standard & Poor’s and Russell.
iShare started their ETF family back in 1996 by the Morgan Stanley and Barclays Global investor with its very fist launch of exchange trade products under the WEBs, World Equity Benchmark Funds.
In 2000, the firm launched their ETFs in U.K. and U.S. along with making first debut in Canada. Later in 2009, BlackRock through a deal comprising of cash-stock acquired iShares.
With more than 100 products on their list on London Stock Exchange, it is no surprise that db x-trackers are one of the big names of the leading ETF providers within UK that offers access to domestic as well as international markets.
ETF SECURITIES UK:
Provider of the Exchange Traded Currencies and Commodities, ETF Securities UK is the third generation of ETF. It was management of that ETF Securities that pioneered development of the ETCs, making it first listing of the ETC, the Gold Bullion Securities in the London and Australia in 2003, drifting to world’s very first ETC platform that was officially listed on London Stock Exchange back in 2006.
The ETF Securities is best known for providing accessible as well as liquid investment solutions which enables the investors to diversify their existing portfolio by going beyond the traditional strategies.
Currently, the firm offers a huge range of the specialist exchange traded products that cover commodities, thematic equities, FX and trading on some of the major exchanges around the world.
The main mission of the ETF Securities is to provide in detail understanding of investment marketplace that are related to the Exchange Traded Products by improving as well as increasing education material that is available to the individual and private investors.
Launched back in 2009, Source is one of the biggest providers when it comes to ETF and ETPs, exchange traded products. The firm is owned by private equity firms as well as five largest equity trading houses.
Being backed by biggest names, the firm has been able to maintain its independence all this time while enjoying benefits from the widespread global reach as well as trading capabilities.
Source offers lowest cost exposures when it comes to traditional equity along with commodity benchmarks and fixed income. Furthermore they have built a great reputation for the innovation.
Source was the first provider in the Europe that launched some actively managed ETFs. Moreover, they are also the pioneer of the investment strategies of “smart beta”. The main aspect of Source is to provide investors a variety of products that are best when it comes to meeting demands of the investors that happen to change every now and then.
It is also one of the most transparent firms when it comes to fees of all the ETPs. They also publish their performance on daily bases on their website in order to enable their investors to keep an eye on efficiency of individual ETP.
The firm Vanguard was the first one to launch the very first retail mutual index fund back in 1976 in U.S. Ownership of structure of Vanguard Group in U.S. is what makes Vanguard stand out from other competitors.
Vanguard is not owned by any group of the individuals or is publicly traded but they are instead owned by ETFs and funds that are US-domiciled which are in turn owned by different investors.
Vanguard has a very unique mutual structure that aligns with its investors which reflects on their culture, policies and philosophy throughout the organization all over the world. Transparency is one of the main elements that set this firm apart from other ETF providers.
Vanguard are excellent when it comes to commuting with their clients which help them to explain how the product work and what costs or charges they have to pay.
A major part of ETF revolution, ProShares has been around since 2006. It didn’t take long for the company to establish their name. Currently, the company is one of the biggest lineups of the ETFs and owns over $27 billion in the form of assets. These ETFs are designed in a way that allows the investor to take speculative and hedging position without purchasing the derivatives.
There are over dozen of ETF products that are offered by ProShares. Each and every product is designed in a special way to perform different speculative investment strategies. The ETF products are divided in three different categories which are alpha, ultra and short.
Alpha tracks performances of Credit-Suisse index; Ulta amplifies the performance of the market using a factor of the two. Short behaves like an inversely to market. Strategies like alternative, dividend and geared growths are lead by ProShares.
Tips To Follow While Choosing ETF
The Investors who know their job well and are considered as the pros of the market analytics have also started to notice the importance of this ETF. The money invested in ETF’s is seen to have increased by five times in the recent years.
Investors now have hundreds or even thousands of ETF’s to choose from as the number of existing ETF’s is seen to be increasing with the passing second. This very number is pretty small in front of the mutual funds in the market but, this speed of increasing ETF’s cannot be ignored as it represents a lot of growth.
As the ETF’s have grown and gained popularity due to various reasons in the industry and the expanded menu has also shown growth and more scope of growth in the industry. With this situation at hand, it must be very hard for the investors to choose the right ETF from a considerably larger menu. This is a challenge that can be easily tackled if the investor follows a specific set of steps explained as follows:
Determine an Objective:
- While one is saving for a vacation or for any other reason for example, say, retirement, it is always very important to analyze what you are saving for and what is your goal so you can link your investments to serve this main goal.
- A classic example of this would be that short term bond ETF’s may be suitable to you in case your goal is for a shorter time period and vice versa, an Equity ETF’s might suit you better if your goal is for a longer time period. At the same time, a dividend ETF might be useful to you if you seek regular income.
- Summarizing this, being aware of your income needs and being aware of how long you have to invest can aid you to choose smartly.
Focus on your Point of View
- One does not need a specific kind of expertise to invest in ETF’s. Focusing on your objective helps in staying updated on what is happening in the financial markets.
- For instance choosing a currency hedged ETF or not, is made simpler by knowing the value of the respective currency and having a defined view on how it may be handled. At the same time, a specific view that equity markets will remain volatile may lead you towards a minimum volatility ETF that seeks to buffer against it.
- Having a better understanding of what you expect exactly and what your preferences are, you will have a better chance of finding the most suitable and right ETF’s to match.
Do you Research on the Fund Providers:
- With the rising popularity of ETF’s, the number of fund providers keeps on growing as well but it has to be kept in mind that with every new entrant in the market, what gets more important is who is who and who can provide you with what offer.
- When you are selecting a specific fund, you should do your research on who your provider is and how much of an experience does he have in the ETF industry as well as the global financial market because, only then he can provide you with the right funds.
- Find answers to questions like, will the fund provider be around for long term? Can they out market details or insights to work for you? Do they have assets under management to support trades? These questions are keys to selecting the right fund provider.
How To Choose ETFs:
There are some important factors that every investor should keep in mind while choosing ETF. Some of them are as follow:
Level (NAV or net asset value) of the assets:
In order to consider it to be a viable investment, the ETF should have some minimum level (NAV or net asset value) of the assets. In general the common threshold for the ETF should be minimum $10 million. Any ETF that is with the assets below this given threshold will have a very limited interest from the investor.
Every investor should check that the ETF, he is choosing is considered to be trades in the sufficient volume on the daily basis. There are some ETFs that have very little trade while trading volume in some of the very famous ETFs runs into almost millions of shares. The trading volume can be used an indicator of the liquidity. In general terms, the higher trading volume for the ETF means that it is more likely to be liquid and tighter will be the bid ask spread.
Underlying asset or index:
Another important factor to consider is underlying asset class or index on which ETFs are based. Keeping in mind the importance of the diversification, it is more preferable to choose an ETF based on the board, followed index, instead of investing in obscure index which has geographic focus or narrow industry.
Most of the ETFs track closely their underlying index, however, there are some who don’t pay much attention on tracking them. An ETF that has a low tracking error is considered to be preferable as compare to the one that has greater tracking error.
Physical vs Synthetic Replication:
The physical ETFs track their index by representative sample or holding all of underlying securities that together make up index. Physical replication moves around buying as well as selling of the components of the index; can be subject to closely tracking errors or labor intensive, depending on what is quality of ETF. While buying underlying assets most of the providers choose optimized sample or all of them. There are opinions when it comes to physical replication.
Some argue that they need to be splitted in two categories i.e. sampling should be separated from the full replication. If compared, full replication is the one that is more common and usually known as the reliable one. However, in global markets the physical replication is not considered to be always appropriate one since when it comes to cost of the carrying out transactions, it isn’t in best interest of portfolio. On the other hand, sampling reduces administrative costs, however, it don’t track full index which increases the chances of errors.
Synthetic ETFs are known for tracking any particular index simply by relying on the derivatives which may be swaps to execute investment strategy. The swap is basically a contract deal between two different parties in order to exchange the flow of cash over a certain period of the time. The agreement would be between the counterparty and ETF to pay ETF returns of index, excluding the fee. Synthetic ETF tracks index with owning no securities. The swap decreases the tracking error as well as the costs.
There are three reasons due to which there are concerns raised in market by Synthetic ETFs, do they actually deliver everything they promised? Are the easy to understand for the investors? As collateral, what are synthetic collateral. Synthetic ETFs are considered to be a better option for the investor to hand their hands on the exposure to the market that are hard to access. Synthetic ETFs are also considered to be very useful when underlying investments are expensive one to buy, sell or hold.