Whilst Exchange Traded Funds (ETFs) are still considered the new kid on the block their popularity and importance can no longer be over-looked by investors who are finding it harder than ever to achieve the returns they desire.
At JPM we believe that there is real value to be gained from ETFs but are they right for everyone? It’s worth taking a moment to understand what they are and how they can form part of your investment strategy.
ETFs were first introduced to the UK in 2000 and just like mutual tracker funds they mimic the performance of a particular market, commodity or index with their value determined by how much the index rises or falls. Their popularity has increased substantially in the past 5 years and there are now over 500 of them listed on the London Stock Exchange including many specialist funds.
Probably the most publicised advantage of ETFs is their low running cost and, on average, they will levy a much lower annual charge of anything between 0.1% and 0.5%, compared with 1.5% on an average mutual fund. Keep in mind though that every trade will incur a commission to buy and sell ETF shares which may quickly start to accumulate dependant on the number and size of trades you make.
As Mutual funds are normally only priced once a day you have the constant frustration of not knowing what price was used to buy or sell until the day after the transaction took place. ETFs are traded like individual stocks and priced continuously throughout the day allowing a much more accurate indication of your commitment. If you are going to be active with your investments and attempt to benefit from shorter term movements then ETFs will allow you greater freedom.
Diversification is the key to reducing the amount of risk and ultimately improving the return on your portfolio but sometimes a mutual fund can provide unwanted diversification. For instance, if you wanted exposure to gold through a mutual fund you may find that this could only be achieved by accepting exposure to other commodities that the fund manager has chosen within the fund’s mandate. This dilution could be avoided by investing into a Gold ETF.
For some investors this freedom can also be the main downside as that there is a much higher level of risk involved with ETFs and sometimes the ability to invest in a very specific part of the market can lose you money just as quickly as make it.
So why isn’t everyone using ETFs? Traditional fund managers would argue that by purely tracking an index that you are not benefiting from the expertise of a fund manager. Well in some instances this may be true but there are just as many examples of investors being charged active fund prices for tracker fund (or worse) performance.
It’s also important to appreciate that not all ETFs are created equal so in the coming months we will start to look in more detail at the opportunities they offer to investors.