An exchange-traded fund (ETF) is an investment, that like a unit trust, offers you easy access to either a basket of shares, bonds or other securities or to a commodity.
Unlike unit trusts, however, ETFs are bundled in a single share that is always listed on a stock exchange.
The basket of securities in which most ETFs invest are those in an index of a market, such as the JSE, or in an index, like the S&P500, which tracks securities on a number of markets.
Some ETFs invest in an index that is designed to mimic an investment style. All of these ETFs, however, track an index.
Those that offer access to a commodity track the price of a commodity such as gold, platinum or palladium.
South Africa’s most popular ETFs track the indices of the top 40 largest shares on the JSE.
Like a unit trust, you pool your money with that of other investors to invest in the same set of securities in financial markets. This enables the ETF provider to give you a diversified investment for a low minimum investment amount.
Always tracking
While unit trust funds may track an index or be actively managed by fund managers who select the shares or bonds, ETFs always track an index or the price of a commodity.
ETFs are therefore often referred to as passively managed or rules-based. Rules-based is the term the investment industry uses for newer indices that mimic investment styles. They aim to beat the market through an investment process that follows rules.
Index-tracking or rules-based investments do not need large investment teams to research and take active decisions on the shares or other securities in which to invest.
This makes ETFs low cost in the same way that index-tracking unit trust funds have low investment management fees.
Your choice of index-tracking investments is, however, broader among ETFs.
As ETFs are listed, you can buy and sell them through a stockbroker. To do so you will need to open a stockbroking account.
Alternatively, there are investment platforms that bulk investors’ ETF purchases and sales through a stockbroker, giving you more affordable investment amounts and lower fees.
These platforms also make it easier for you to buy and sell ETFs from different providers on a single platform.
Most ETFs are also collective investment schemes – but a few that invest in commodities are not, because they do not comply with the investment restrictions in the Collective Investment Schemes Control Act. Schemes are not allowed to invest in instruments that provide for physical delivery of commodities.
Advantages of ETFs
The advantages of investing in exchange traded funds are:
An ETF can be bought as a single share, but gives you access to a portfolio of underlying shares and the benefit of diversification.
Diversifying across shares in this way reduces your risk and the volatility of your investment.
You pay brokerage and JSE charges to buy an ETF, but if you bought each share, for example, in the index, you would pay brokerage and charges on each share. Instead, the costs of buying the underlying shares is priced in the fund.
There is transparency about the investment holdings – you can see the holdings in an index daily.
You can see the price of the ETF or net asset value throughout the day when the market is open.
