Investing Shares

ETF’s: 7 Things to Do Before You Buy an ETF

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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:

Complete list of ETF’s available on the ASX

ETF Performance Table

 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.

MER: Management Expense Ratio is the investment cost of the ETF, disclosed as a percentage.

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:

ETF - MER

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:

 

ETF Benchmark

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:

ETF Hedged or Unhedged

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.

Source ASX

The Risk

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).

ETF - Synthetic

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

ETF Growth - Dec 2016

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:

ETF Leverage and Options

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:

ETF Inverse

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.

NAV: Net Asset Value is the per-share value of the ETF.

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.

ETF - NAV 2

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

WARNING: Never trade ETFs during ASX market opening (10am – 10.20am) and closing times (4pm – 4.10pm) as the market makers who manage the buy and sell prices for ETFs do not operate during these hours. During these hours the market price and the NAV will be different so don’t risk paying the wrong price (or selling to cheaply).

Summary

  • 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 
 The Wealth Guy Signature
The information on this blog and website is of a general nature only. It does not take into account your individual financial situation, objectives or needs. You should consider your own financial position and requirements before making a decision. We recommend you consult a licensed financial adviser in order to assist you with this.

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