ETFs are easy to buy, but that doesn’t mean you don’t have to do any research.
Here are 7 things you should review before you buy an Exchange Traded Fund (ETF).
Useful Information For This Blog
Here are some useful links for investing in ETFs:
7 Things to Review Before You Invest
Here are 7 things you should always review before investing in an ETF.
1. The Fees
Generally speaking, when it comes to ETFs the lower the fee the better. ETF fees are quoted as MERs.
Reviewing the Fees
A full list of the ETF’s available on the Australian Stock Exchange (ASX), can be found HERE
Once the page loads you want to scan through the available ETFs taking note of the MER quoted as follows:
Fees can have a big effect on your investment returns, so choose your ETF carefully.
2. The Benchmark
Most exchange traded funds seek to replicate the investment exposure and performance of an underlying investment benchmark.
Benchmarks are generally broad market indices like the ASX 200 index, Nasdaq index, or even a Global Healthcare Companies index. There are thousands of benchmark indexes globally.
Finding the Benchmark
You can find the benchmark indexes for each ETF in the column as follows:
Try to find the benchmark that is the closest match to your investment objective.
3. Is it Hedged or Unhedged?
When you invest in international shares and ETFs we have to consider the effect of currency.
For example you might get the investment exposure right and the stocks in the ETF go up, but if the currency moves against you, you could still lose money.
What’s the Difference?
Hedged ETFs were developed to remove that currency risk from the investment.
- If the Australian dollar is going up, hedged ETFs will do better.
- If the Australian dollar is falling, then unhedged ETFs will do better.
If an ETF is hedged it will be listed in the table as follows:
Choose hedged if you only want investment returns to be a factor, choose unhedged if you want currency to factor in your return as well
4. Is it Synthetic or Asset Backed?
Most ETFs are asset backed, which means they are required to actually own a portfolio of shares behind the ETF product.
On the other hand synthetic ETFs use derivates to replicate the benchmark, they don’t actually own the underlying shares.
Synthetic ETPs and Structured Products use derivatives to achieve their investment objective. If you invest in these you are subject to the risk that the counterparty to the derivative may fail to meet some or all of their obligations.
In theory if a synthetic ETF failed you may end up with nothing, while an asset backed ETF will leave you with the underlying shares (to my knowledge no ETF has ever failed in Australia).
The VanEck China ETF highlighted in the table above is synthetic because the Chinese stock market is not 100% open to foreigners, meaning it is very hard to buy the stocks you need to replicate the index.
Always review the ETFs PDS and in particular the counter-parties the ETF provider uses. Make sure you are comfortable with the counter-party risk before making a decision to buy.
The ETF Market is Growing
The use and availability of ETFs in Australia continues to grow rapidly.
- $26 billion was invested in ETFs in Australia (as at 31 December 2016)
- The market has grown 30% per year from an almost standing start in 2004
- At the end of 2016 there were almost 200 different ETFs available to Australian investors
5. Does it Use Leverage or Options?
Some Exchange Traded Funds will use borrowings (leverage) or options (derivative) strategies as part of their investment objective.
Disclosed as Follows
You can easily see whether an ETF is using leverage or options in the following columns:
Make sure the ETFs leverage strategy matches your investment objective – remember leverage multiplies the upside as well as the downside.
6. Is it an Inverse Exposure?
Some ETF offerings are designed to move inverse with their relevant benchmark, meaning the ETF will go up if the benchmark index goes down.
The result is the exact opposite of most other ETFs.
Why would you want this?
If you think the Australian share market is going to crash, you may want to consider buying an inverse ETF so you can profit when this happens.
You can easily see whether an ETF is inverse in the following columns:
Only use an inverse ETF if the strategy matches your investment objective – the potential for loss on short investments, is unlimited (in theory a stock can go up in value to infinite, but only down in value to zero)
7. Check the Correct Price (NAV)
All ETF providers are required to disclose the true price of their ETF on their website, known as the NAV.
You won’t be able to trade in the market exactly at the NAV price, but you should make sure that buy and sell prices (bid and offer) are within a couple of cents of the NAV price.
Example of NAV Disclosure
Here is an example of the NAV disclosed with the bid and offer prices.
Always check the NAV before you place your order. If the price on the ASX is more than a few cents away from the NAV call the ETF provider and ask them why
- ETF stands for Exchange Traded Fund
- ETF’s are usually provided over market indexes and themes
- Before you trade an ETF you need to do your due diligence