If you are looking to diversify your investments, hedge against risk, or gain exposure to a certain market sector, ETFs can be the perfect asset for your portfolio. Investors who take advantage of ETFs and include them as part of their trading strategy reap many of these benefits.
Cost-Effectivness – ETFs can be economical to buy and especially cheap to maintain over the long run, making them especially popular for long-term buy and hold investors and ideal for cheap investment exposure in self-managed superannuation funds (SMSFs). Annual fees can be as low as 0.09% per annum as opposed to managed funds who on average charge around 1.5% per annum. The other cost advantage investors get within index ETFs is being able to essentially buy a stake in all of the shares in the index with one simple trade.
Single Transactions - ETFs act like indexes and follow certain market sectors. However, unlike an index, you can purchase an ETF with one single transaction. You are purchasing a mini-portfolio, not a basket of stocks. That makes life easier when targeting a certain price.
Product Flexibility – Part of the reason ETFs are so popular is due to the ease in which investors can placed funds into securities that are not easily traded through large exchanges. For instance, investors can choose to trade gold (ASX code: GOLD) which comprises a Gold Bullion Share (a redeemable preference share issued at a nominal value of 1/1,000th of a cent), carrying with it an entitlement to approximately 1/10th of one fine troy ounce of gold bullion held in the name of the Trustee, Gold Bullion Nominees Pty Ltd.
Passive Management - ETFs are meant to follow a particular index, not outperform it. Therefore, only minor adjustments are needed for the ETF, as opposed to an aggressively managed fund. This in turn lowers risk and management fees.
Simplicity - ETFs are simple in structure and easy to understand. If you are looking to invest in a certain industry or want to emulate the ROI on a particular index, you are only a trade away from getting started with ETFs.
Diversification – With a lot of ETFs, especially index ETFs, you can essentially buy a basket of securities in one trade. To a large degree, this negates company specific risk. This is especially beneficial in the current economic climate when discounting capital raisings are especially prevalent. Just recently Suncorp-Metway (SUN) offered a pro-rata entitlement at a 37% discount to the previous traded price. As a result, SUN traded 31% lower on the day it came out of the trading halt, the ASX200 index was up around 1% at the same time.
Liquidity – A major advantage of ETFs over managed funds are due to the fact that they are “exchange traded”. ETF’s can be bought and sold at intraday prices, short sold, purchased in a margin loan account and traded using stop-loss and limit orders.
Performance Transparency – ETFs are designed to very closely track performance of the underlying security/index. It is for this reason that unwarranted moves in the price of the ETF can be very easily monitored.
Distributions – all index ETFs collect the full dividend/interest component of its constituents and in turn pay it out pro-rata to the ETF shareholder, generally bi-annually. The payments of the dividends are also accompanied by franking credits which increases the tax effectiveness of the fund.
Tax Advantages – ETFs have a unique process called creation/redemption in-kind (meaning shares of ETFs can be created and redeemed with a like basket of securities) that avoids the costs associated with constant rebalancing. This in-kind feature of ETFs negates the need to sell the underlying securities which would trigger tax events. Of course, an investor selling ETF shares may realize capital gains or losses, as with common stocks.
