What are ETFs?

Exchange-traded funds (ETFs) have become a popular investment option in recent years. In fact, ETFs have grown to become a multi-trillion-dollar industry, and their popularity is only increasing. But what exactly are ETFs, and why are they so popular?

At their core, ETFs are investment funds that trade on an exchange like a stock. They hold a basket of securities, such as stocks, bonds, or commodities, and can offer investors exposure to a wide range of asset classes and investment strategies. ETFs can also be designed to track specific indexes, sectors, or regions of the world.

Benefits of ETFs

One of the main advantages of investing in ETFs is their low cost. Since ETFs are designed to track an index or a specific basket of securities, they do not require active management. This means that ETFs can offer exposure to a diversified portfolio of securities at a fraction of the cost of actively managed funds. This means that investors can keep more of their returns instead of paying high management fees.

Investing in ETFs provides investors with exposure to a diversified basket of securities. ETFs are designed to track a specific index or sector, allowing investors to gain exposure to a wide range of assets. This diversification can help to reduce overall portfolio risk by spreading investments across different companies and industries.

Another advantage of ETFs is their flexibility. ETFs can be bought and sold throughout the day on an exchange, providing investors with the ability to trade them like a stock. The ETFs that we invest in are also highly liquid, meaning they can be bought and sold throughout the day on stock exchanges. This makes it easy for investors to quickly enter or exit their positions in response to market changes.

ETFs are also known for their transparency. Because ETFs track an underlying index, the holdings of the ETF are typically disclosed on a daily basis. This level of transparency allows investors to know exactly what they are investing in and make informed decisions about their portfolio. It is also because of this that there are far fewer actively-managed ETFs available on the market, as fund managers typically prefer to protect their intellectual property by only disclosing their full portfolio holdings when needed.

Downsides of ETFs

However, like any investment, ETFs do come with some risks. One of the main risks is the potential for market volatility. Since ETFs trade on an exchange, their price can fluctuate throughout the day, and they are subject to the same market risks as the underlying individual securities they invest in, whether they be stocks, bonds, or commodities.

Additionally, some ETFs may be more complex than others and may carry higher risks. For example, leveraged ETFs use derivatives to amplify their returns, but they also amplify the potential for losses. Synthetic ETFs also use derivatives to replicate the index without ever buying the underlying asset, whereas physical replication involves the ETF physically owning the underlying asset. The use of derivatives introduces counterparty risk, which is the risk associated with the other party to a financial contract not meeting its obligations. Therefore, the preference is to invest in fully physically replicated ETFs to mitigate counterparty risk.

Selecting ETFs

Like with all investments, it’s important to fully research and understand what you are investing in. When selecting ETFs to invest in, we have a robust screening and scoring process which considers a range of key factors such as liquidity, compliance structure, replication method, tracking error (the accuracy of the fund in tracking its benchmark), value-for-money, and more.

Overall, ETFs can be a great investment option for investors looking for low-cost, diversified, and transparent exposure to a specific asset class or index.