About Exchange Traded Funds (ETFs) and Exchange Traded Commodities (ETCs)

Today there are over 60 ETFs / ETCs accessible through ASX. A single trade in an ETF or an ETC can provide or add instant diversification to your portfolio. More information on ETCs is available.

Exchange Traded Funds or ETFs are investment funds, traded on an exchange, that invest in a basket of securities or other assets and that generally seek to track the performance of a specified index or benchmark (such as the S&P/ASX 200 index). They are typically registered managed investment schemes (MIS) and investors hold units in a unit trust rather than shares in a company that operates the investment fund. Each ETF security (or unit) represents an interest in a portfolio of securities, currencies or commodities.

ETFs are open-ended funds, which means that the number of units on offer is not fixed but can increase or decrease in response to demand and supply from investors, which helps to ensure that the ETF units trade at or near their net asset value (NAV). Typically only ASX authorised participants can apply for or redeem ETF units directly with the fund, but others can trade on the market throughout the day at prices established by the market. 

Types of ETFs

Not all ETFs are the same. Different types of ETFs have different risk and performance characteristics for investors. General risks include market risk, tracking risk and potentially currency risk (unless hedged). You should always carefully read the product disclosure statement which provides detailed information related to the ETF's investment objectives, principal investment strategies, risks and costs, before deciding to invest or not.

While all ETFs seek to achieve the same return as a particular market index or benchmark, there are generally two common ways for an ETF manager to track the performance of the relevant index or benchmark.

Conventional ETFs

Conventional ETFs seek to achieve the same return as a particular market index or benchmark. This type of ETF is similar to an index fund in that it will primarily invest in the securities of companies or other assets that are included in a selected market index or benchmark. An ETF will invest in either all of the securities or a representative sample of the securities included in an index or benchmark.

Synthetic ETFs

Synthetic ETFs do not necessarily invest in the securities included in an index or benchmark (unlike conventional ETFs), but rather they aim to replicate the performance of the index or benchmark synthetically. They do this by holding financial instruments like swap agreements or futures contracts (collectively 'derivatives') to simulate the investment performance of the index or benchmark for the whole fund. The derivatives will require the ETF to pay or entitle it to receive payments so that the return to the fund (before fees) reflects the performance of the index or benchmark not the assets actually held. Apart from any money owing from the derivative counterparty, the remainder of the fund's value is generally invested in other assets, which may or may not reflect the index or benchmark because the performance of the assets will impact on the derivative counterparty not the performance of the ETF. 

More information regarding synthetic based ETFs including specific risks associated with this type of ETF is available.

Benefits of using ETFs

Buy / sell flexibility - ETFs and ETCs are traded on the ASX and this means that you can buy and sell at any time during ASX's trading hours, at prices that you specify. This means you can enter and exit an investment in ETFs as you would a share and be assured of three day settlement.

  • Low cost - as ETFs and ETCs are typically able to achieve lower operating costs, the management fees (commonly referred to as MERs - Management Expense Ratios) are significantly lower than other managed funds or the expense in holding physical commodities directly.
  • Returns from capital appreciation and income - an ETF or ETC will change in value as the underlying portfolio of assets changes in value. Depending on the benchmark being tracked, investors can earn returns through capital appreciation and/or distributions. Investors may also enhance after tax returns from franking credits.
  • Fair value - ETFs and ETCs are designed to ensure that they trade close to their underlying value. This provides the investor with certainty that the on-market price will closely reflect the value of the underlying assets held in the fund. This is commonly referred to as trading at net asset value (NAV).
  • Taxation advantages - the turnover of the underlying portfolio tends to be low with the constituents of ETFs changing only when there is a rebalance of the index. This means that the level of capital gains tax that needs to be paid by the fund and its investors can be greatly reduced.

Risks or disadvantages of using ETFs

  • Market risk - market conditions (for example, lack of liquidity) may make it difficult to buy or sell ETFs in certain circumstances.
  • Use of derivatives and counterparty risk - ETFs that use derivatives could cause the ETF to incur losses. Some ETFs (for example, synthetic ETFs) generally use over the counter (OTC) derivatives, which are not subject to central counterparty clearing arrangements.  Central counterparty clearing arrangements, where available, help to mitigate counterparty risk.
  • Exchange rate fluctuations - ETFs which seek to achieve the same return as a particular overseas market index or benchmark, and are traded and settled on ASX in Australian dollars, may be exposed to additional risks. If the ETF is not hedged against currency risk, fluctuations in the exchange rate can affect the value of the portfolio. Additionally, there may be political risks in the home country of the overseas market or benchmark which may also affect the value of the portfolio.
  • Tracking error - the return on the portfolio may deviate from the return on the index or benchmark tracked. A portfolio that is a selected sample of the index or benchmark will not perform exactly like that index or benchmark.
  • Taxation outcomes - there may be different taxation outcomes for investors in synthetic ETFs when compared with conventional ETFs, depending on whether any gains or losses in the ETF are achieved through holding the assets that make up the index or are achieved through the derivative exposure.  Any different taxation outcomes may significantly impact the effective return for investors in synthetic ETFs.

Range of ETFs and ETCs

There are conventional and synthetic ETFs available to trade on ASX covering a wide range of asset classes. These include;

Investing

Investing in ETFs is easy as they trade in exactly the same was as any other share on the ASX. The major providers of ETFs and ETCs on issue on the Australian Securities Exchange include Australian Index Investments (Aii) , BetaShares, iShares, Russell Investments, State Street Global Advisers (SSgA) and Vanguard Investments.

    Market Making

    Market Makers provide an important role in ensuring that buyers and sellers of ETFs and ETCs can transact. They provide liquidity to the market by providing quotes through the trading day and update their prices to reflect changes in the underlying securities.

    ASX offers a Market Making incentive scheme to further promote tighter spreads and more liquidity in the ETF (Exchange Traded Funds) and ETC (Exchange Traded Commodity) markets. Market Making Participants receive Trading and Clearing Fee incentives from ASX when achieving minimum quoting benchmarks on a monthly basis. Each ETF / ETC is assigned a spread and liquidity requirement.

    The table found in the following PDF (224KB) shows the Market Makers (MM) that have signed incentive contracts with ASX and the relevant ETF/ETCs.