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ETFs - a short primer

At Six Park, we believe that Exchange Traded Funds (ETFs) are an ideal investment vehicle for our clients. In just a few trades on the ASX, it is possible to instantly and inexpensively create a truly diversified portfolio. For example, we provide our clients with international share exposure through a Vanguard International Shares ETF. It holds shares in Apple, Google, Microsoft, Facebook, GE, and Nestle, amongst 1,500 other high performing global companies – all in just one single fund.

ETFs are now one of the fastest growing investment products in Australia and the world. There are now around 200 different ETFs listed on the ASX (up from just 37 five years ago) with over $24.5 billion of total funds under management. More than $2.5 billion worth of ETFs were traded during November 2016 alone - so they are an increasingly popular investment tool for many investors.

What is an Exchange Traded Fund (ETF)?

They’re popular, they’re growing, but what exactly is an Exchange Traded Fund? Quite simply, an ETF is a type of fund that trades on the share market, much like a share of say Telstra or BHP. Rather than investing in just one security, an ETF typically invests in a basket of assets. These assets might be shares, bonds, property, currencies or commodities, usually with a focus on a particular geography, industry or market. When you buy an ETF, you basically buy an interest in that ETF’s basket of assets.

Many ETFs are designed to track a particular market index, such as the ASX200 or S&P500 index. They do this by buying every (or almost every) share/bond/asset in their target index – usually in the same proportion that those shares/bonds/assets represent in that index. In doing so, ETFs mimic the performance of their targeted index - but with low costs and high tax efficiency.

ETFs operate as “open-ended” funds. This means that the number of units on issue is not fixed and instead increases or decreases in response to investor demand and supply. This process helps ensure that ETFs trade at or near the net asset value (NAV) of their underlying holdings. You can read more detail about how ETFs work on the ASX’s website.

The Benefits of ETFs

We use ETFs across all our Six Park portfolios because they offer a range of benefits:

  • Immediate Diversification – With just a single trade, an ETF can provide instant exposure to hundreds (if not thousands) of positions within a specific asset class (e.g. all the shares in ASX200), rather than needing to buy all those underlying exposures individually.
  • Cost efficiency – ETFs can be very cost effective. The management fees charged by ETFs are generally much lower than those charged by an equivalent actively managed fund or the costs you would incur to trade those securities individually yourself.
  • Asset allocation simplicity - ETFs offer investor’s ready access to practically any asset class, geographic region and investment strategy.
  • Flexibility – ETFs can be bought and sold during market hours et hours just like any other listed share. Investors are also able to place limit and stop orders just like they would with any other listed instrument. This makes ETFs a flexible, liquid and readily tradeable investment proposition.
  • Transparency – ETFs generally publish their underlying holdings on a daily basis so investors always know what they are buying and where their funds are invested. This provides much greater transparency than traditional managed funds, which typically report their holdings monthly or quarterly.
  • Tax efficiency – ETFs generally have much lower levels of portfolio turnover compared to actively managed funds (which tend to buy and sell assets more frequently). Lower portfolio turnover can help reduce/defer capital gains tax levels and improve overall post-tax returns. The unique structure of ETFs (in which units are bought/sold from market makers) also means investors are better insulated from paying capital gains tax triggered by the redemption actions of other (read more here).

The risks with ETFs

As with any investment, there are always potential risks with using ETFs. These include:

  • Market risk – The value of an ETF will rise and fall in line with the value of its underlying assets. If these assets decline in value, ETF holders may experience a loss of capital and/or income. This risk is inherent in all investments, particularly with shares and other growth assets whose prices are influenced by investor sentiment and other market factors)
  • Pricing risk – There may be times or circumstances where the market price of an ETF may not properly reflect its net asset value (e.g. where the ETF’s underlying assets are illiquid). This may result in investors paying too much for an ETF (or selling too low). Generally ETF issuers engage firms (called market makers) to try and ensure their ETF pricing remains close to net asset value.
  • Tracking errors –Fees, taxes and other factors can all influence how closely an ETF is able to track its target index. This tracking error differs across ETFs and can influence investor returns.
  • International exposure risks – If an ETF with overseas assets is not hedged against currency risk, fluctuations in exchange rates will affect the value of its portfolio. There may be overseas political factors which may also affect the value of the portfolio.

Our Approach:

At Six Park, we spend a considerable amount of time reviewing and assessing the ETF marketplace, taking into consideration many factors including fund size, liquidity, tracking error and relative costs. Our ETF selections are regularly reviewed to ensure they represent the best available investment option for our clients.

As a Six Park client, you will be invested in a portfolio of high quality ETFs that are carefully selected by our expert investment team to match your recommended asset allocation.

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