Investing

The market for global exchange-traded funds is booming as an increasing number of investors seek alternative investment vehicles, transparency and diversification by asset class and geography.

In Australia, there’s been annual growth in the ETF market of almost 50 per cent for the past three years (to 2011) says the head of index services for Standard & Poor’s in Australia, Guy Maguire.

Just like shares

Because ETFs are listed on an exchange they can be bought and sold like shares via an online broker, traditional broker or through an intermediary.

BetaShares’ head of investment strategy and distribution, Drew Corbett, says ETFs give investors exposure to various international asset classes, such as equity markets and foreign currencies.

“If you do want to send money overseas there’s a huge pool of ETFs available. Literally every asset class and sector is covered by an ETF – such as fixed-income ETFs, commodity ETFs and even home-builder ETFs,” he says.

Two structures

Broadly, there are two types of ETF structures. A conventional ETF typically invests in all the securities of the index or at least a representative sample, whereas a synthetic ETF invests in the index through derivatives, such as swaps, which exchange the security with another held by a counter party to match the performance of the index. In Australia the counter party must be a bank.

Maguire says a provider using the index methodology should have robust criteria for the inclusion of a particular index and ensure an appropriate level of liquidity across the constituents of that index.

Typically, the index should support a low turnover of constituents to keep management costs down, allowing the issuer to offer competitive management fees. You should find the fees disclosed on ETF providers’ websites.

Some disadvantages

While ETFs tend to be cheaper than managed funds, there are still costs to consider, including online trade and broker payments, which range from $20 to $30 for each transaction.

Global ETFs are considered far more liquid and transparent than managed funds but they do have their disadvantages. The biggest of those relates to the fact that they track an index and are passive by nature, so they’re not designed to deliver outperformance.

Investors who are considering ETFs need to be certain of two things: the appropriate asset allocation; and the appropriateness and trustworthiness of benchmarks to accurately measure the allocation.

Index integrity is based on a number of things, including transparency, reliability of data, a robust process and independence of the index provider.

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