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Invest like the professionals

ETFs offer all the benefits of a managed fund with the added feature of being listed on the ASX.  In this article we look at what ETF's are and how they can be used.

Exchange Traded Funds (known as ETFs) have been around since 1989, with the first ETF listing on the Toronto Stock Exchange.  Since then over 350 ETFs have been listed on 28 exchanges around the world, including Australia, making them one of the fastest growing investment products around the globe.

What exactly are ETFs?

ETFs are ASX listed index tracking funds that invest in a portfolio (or basket) of securities, which may include:

  1. Australian shares
  2. International shares
  3. Fixed income securities
  4. Listed property trusts, or
  5. A combination of asset classes. 

Often touted as ‘hybrids’ between shares and managed funds, ETFs combine the tradability and convenience of shares with the diversification and simplicity of managed funds.

What are examples of ETFs?

If you want to gain exposure to the Australian sharemarket, you can now invest in the “Top 50” and “Top 200” shares in Australia using the State Street streetTRACKS products.  Alternatively, you can gain exposure to the listed property trust market via the streetTRACKS S&P/ASX 200 Listed Property Fund, which provides attractive yields (or income) and the potential for capital gains.

How do large institutions use ETFs?

Large institutions have been using classical ETF products for years.  They derive benefits from investing in ETFs when they are looking to change tack in the direction of their portfolio.  They ‘park’ cash, so to speak, in an ETF covering the index they benchmark themselves against, for example the S&P/ASX 200. This allows them to ‘hug’ the index whilst they develop their next strategic play. An investment of this type is appealing to fund managers as it’s deemed to be a ‘safe’ investment, which is of relatively low cost (due low management expense ratios – or MERs) and easy to transfer money in and out of. 

Intra-day pricing and a liquid market gives certainty of pricing, and the price displayed on market is directly correlated to the net asset value (NAV) of the underlying stocks. This means that the price of an ETF should fully reflect the performance of the underlying portfolio.  You will therefore pay for the portfolio’s value, rather than having to factor in additional considerations such as investor and market sentiment. 

Why are ETFs appealing?

Personal investors can now also receive the same benefits as their institutional counterparts, with an investment as little as $2000.   Appealing features of ETFs include:

  • Low cost - MERs are much lower than traditional managed funds ranging between 0.28 and 0.40 per cent, due to low turnover in the portfolio and lower administrative expenses. Investors will incur brokerage on entering and exiting the fund as per any normal share transaction.
  • Solid returns - annualised returns for the State Street streetTRACKS products averaged 20% for the last financial year.
  • Tax advantages - franking credits attached to underlying shares are passed through to the end investor, along with a concessional rate of CGT if the ETF is held longer than a year.
  • Income generation - current dividend yields for the streetTRACKS products (S&P/ASX 50 & S&P/ASX 200) range from 2.4% - 7.53% (as at 30 June 2004).
  • Can be purchased by Self Managed Superannuation Funds (SMSFs)

Are ETFs popular with personal investors in the US?

Overseas, personal investors in markets such as the US have been following the institutional lead for years.  For example, average daily share volume of US ETFs accounts for 55% of all daily equity trades by volume in comparison to less than 1 percent in Australia. The most actively traded ETF in the US is the index-based fund (QQQ) or “Cubes” which tracks the technology laden Nasdaq 100 index. Trading volumes of this ETF generally exceed 50 million shares per day.  Other popular US ETFs include the Standard & Poors Depository Receipts (SPY) dubbed the "Spider", and the Diamonds Trust Series I (DIA) or "Diamonds”.  All are products that were initially used by institutional investors until fee conscious retail investors took note and followed their lead.  These products are also available to Australian investors via the ASX World Link Service.

Where to from here?

For more information on ETFs or Listed Managed Investments in general, please visit the ETF page on the ASX Website.

© All rights reserved 2004. This material is educational and it is not intended to constitute financial advice.

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