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What is an ETF?
An exchange traded fund (ETF) is a basket of securities—such as stocks, bonds, currencies or commodities—that can be bought and sold in a single trade on an exchange. They generally track the performance of an index, less fees, and offer targeted exposure to a specific market segment, such as an asset class, geography, sector, or investment theme.
In essence, ETFs are funds that trade like stocks with the diversification benefits of mutual funds. In one trade, they can offer diversified, low-cost, transparent and tax-efficient exposure to companies across the globe.
What Are The Benefits of ETFs?
Understanding the benefits of ETFs is an important step toward determining whether ETFs can be an appropriate choice for your portfolio.
Target Exposure
ETFs generally track an index, offering exposure to a specific segment of the market such as:
- Asset Classes – ETF proliferation has helped make all market segments easy to access, from equities and fixed income, to commodities and alternatives.
- Geographies – You can access global, regional, or single country focused ETFs, as well as ETFs that focus on developed or emerging markets.
- Currencies – ETFs that track the price return of a basket of currencies, such as all emerging market currencies, or individual ones, such as the Japanese Yen or Chinese Yuan.
- Sectors and Industries – These ETFs track a stock market sector or industry, such as Real Estate Investment Trusts (REITs), Resources, Financials, or Health Care.
- Investment Themes – These ETFs seek to offer exposure to multi-generational investment themes such as Environmental Social Governance (ESG) or the advancement of technology on Cyber Security or Autonomic Vehicles.
- Style/Factors – Smart beta ETFs offer exposures to stocks with attributes like low volatility, value and momentum.
Lower Expense Ratios
Because most ETFs are passively managed, they typically have lower management fees and operating expenses compared to managed funds. Transaction costs are minimised due to the low turnover of most ETFs and the indexes they track. When fees and expenses are low, investors can keep more of their returns.
Increased Diversification
ETFs provide one of the easiest ways to diversify a portfolio.
They provide access to many companies or investments in one single trade, removing single stock risk—the risk inherent in being exposed to just one company. Offering this exposure in the ETF structure helps to lower the risk that a select number of individual stocks could hurt overall portfolio performance.
Added Liquidity
ETFs benefit from two sources of liquidity:
- Primary Market Liquidity – ETFs have a unique creation/redemption mechanism, which allows participating dealers (ADs) to build baskets of ETF shares when demand increases (creation), or disassemble the baskets of ETF shares back into single securities should demand decrease (redemption). This happens in the primary market, and allows the liquidity of an ETF’s underlying securities to enhance the liquidity of the ETF.
- Secondary Market Liquidity – Because they trade throughout the day on an exchange, or in the secondary market, investors can make timely investment decisions and quickly execute based on shifting market conditions.
Learn more about the ETF creation and redemption process
Tax Efficiency
ETFs are generally more tax efficient than other investment vehicles due to the ability to transfer securities in and out of the portfolio in the most tax-efficient manner, via the in-kind creation/redemption process. And, because ETFs generally track market indexes, turnover is generally low, resulting in fewer capital gains and lower taxes. Additionally, any associated capital gains taxes are paid at the time of final sale, offering greater control on the timing of tax consequences.
Flexible Trading
ETFs can be bought through an online brokerage account at their current market price, at any time during the trading day. There are no minimum holding periods, and investors can employ a wide range of trading techniques.
Increased Transparency
The holdings of most ETFs are fully transparent and available daily. This disclosure means investors know what they own at any moment, allowing them to make more informed investment decisions with greater accuracy.
There are risks associated with investing in ETFs. Before deciding whether to acquire or continue to hold an ETF you should read the product disclosure document for a full list of all risks.
Creation and Redemption Process The process whereby an ETF issuer takes in and disburses baskets of assets in exchange for the issuance or removal of new ETF shares.
Limit Order An order placed with a broker to buy or sell a set number of shares at a specified price or better.
Liquidity The degree to which an asset or security can be bought or sold in the market without affecting the asset’s price. Liquidity is characterised by a high level of trading activity.
Primary Market The market where shares of an ETF are created or redeemed.
Secondary Market A market where investors purchase or sell securities or assets from or to other investors, rather than from issuing companies themselves. The Australian Securities Exchange is a secondary market.
Passively managed funds hold a range of securities that, in the aggregate, approximates the full Index in terms of key risk factors and other characteristics.
