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Exchange traded funds (ETFs) can be a simple and low-cost way to get investment returns similar to a shareindexor another underlying asset. However, some ETFs are more complex and risky than others. Here we explain the risks and what you need to know before you invest.
An ETF is a type of investment fund that can be bought and sold on a securities exchange market. In Australia, ordinary ETFs are passive investments that track an asset or market index (for example, the ASX200 Australian share index). They generally do not try to outperform the market and will go up or down in value in line with theindexthey are tracking.
If an investment is called an active ETF then the fund manager is actively trying to outperform the market or index to achieve a different investment objective. Seeother exchange traded productsfor information on active ETFs.
ETFs are available for a broad range of assets including Australian shares, international shares, fixed income products, foreign currencies, precious metals and commodities. They can be used asa way to diversify your investment portfolio, and usually have lower fees than a traditionalmanaged fund.
Standard or physical ETFs buy the underlying investments (such as shares and other assets) on the reference index that the ETF is seeking to track.
If you invest in an ETF, you wont directly own the underlying investments, the ETF will own these, you will own units or shares in the ETF.
Your main investment risk is the performance of the underlying shares or other assets. Other risks are discussed below.
Synthetic ETFs have a material exposure toderivativesas well as the underlying assets that the ETF is seeking to track. Along withthe benefits and risks of physical ETFs, synthetic ETFs haveadditional risks such as the credit risk associated with the derivative counterparty. Find out more aboutsynthetic ETFs.
Some products that also track an index or other investments may look and feel like ETFs, but they are not ETFs. Products labeled exchange traded commodities, exchange traded notes, exchange traded certificates, and exchange traded securities are not ETFs.
There are also active ETFs, sometimes referred to asexchange traded managed funds and exchange traded hedge funds that, unlike passiveETFs, do not simply track an index. They mayuse strategies to tryto outperform an index or seek enhanced returns. The risks of these products can be different and sometimes much higher than the risks of ETFs.
Seeother exchange traded productsfor more information.
The value of a physical ETF investment can rise and fall daily, usually in line with the index it is tracking.
Here are some tips on what to look for before you invest.
You can check if the ETF is fairly priced by comparing the offer price (if youre buying) or the bid price (if youre selling) quoted by a broker, with the latestnet asset value(NAV)information available for the ETF.
Many ETF issuers provide NAV updates in real-time. These real time price updates are referred to as the indicative or intraday NAV or the iNAV. You can access the latest iNAV from your broker by prefixing the ETF ticker code with a Y (for example, YABC for ticker code ABC). ETF issuersmay alsoregularly update their estimated NAVs on their website.
The market price of an ETF unit should be close to the NAV per unit of the underlyingassets. If the offer price you are quoted by a broker is significantly above the NAV, there is a risk you might pay far more for an ETF than its worth. If the bid price is significantly below NAV, there is a risk you could sell for less than the value of the underlying investments.
ETF prices will not exactlymimic the price of the index or investment they are designed to track,due tofees, taxes, and other factors. This is called a tracking error.
Under theASX Quoted Assets (AQUA) marketoperating rules, some issuers need to engage market makers, who aim to ensure that the ETFs price stays relatively close to its NAV. This helps create a more liquid ETF market.
To receive an ETF price that is closer to the value of the underlying assets, place orders to buy or sell units at least 30 minutes after the share market opens.
It is also better tobuy or sell ETFs when the market for the underlying asset is open. For example, if youre buying or selling a fundthat tracks Asian shares, try to place your orders when the Asian market is open. This may reduce price discrepancies between the ETF and the price of the shares that it holds.
While ETFs may have lower fees compared with other managed investments, management fees can vary and may be higher than the fees of an equivalent unlisted or unquoted index fund.
You will also pay brokerage fees when you buy or sell ETF units. If you want to make a small regular investment in a product that tracks an index, you might be better off using an unlisted managed investment such as anindex fundwhere broker fees wont apply to each contribution, although other fees may apply.
The buy-sell spread (the difference between the prices that you can buy and sell ETF units at) could be considered a cost for you when you buy or sell ETF units, although market makers usually ensure the spread remains relatively small.
If youre selling you can work out the buy-sell spread by subtracting the bid price from the NAV to calculate a dollar spread and then dividing the dollar spread by the bid price to get the percentage spread.
If youre buying you can calculate the dollar spread by subtracting the NAV from the offer price, and then calculate percentage spread by dividing the dollar spread by the offer price.
Some ETFs offer exposure to investments such as small companies, emerging markets or commodities that may be harder to sell in certain circumstances, or more complex and volatile than ordinary company shares. This could increase risks for investors.
If the ETF tracks overseas assets, changes in the value of the Australian dollar may also affect the value of your investment. Some funds may be currency hedged to reduce this risk.
When you buy units in an ETF located in another country (but also traded on an Australian market) foreign taxes may apply. For example, if you buy units in a US ETF, US estate taxes may be payable when you die.
Read the PDS to understand how your investment will be taxed, and if youre not sure contact the ETF provider or a tax adviser.
Fixed income ETFs aim to replicate the performance of assets such asbondsanddebentures.
The Australian Securities Exchange (ASX) has restrictions on what indices or non-exchange traded bonds or debentures can underlie an ETF, however the value of the underlying assets may rise and fall, which means the price of the ETF can also rise and fall.
The secondary market forcorporate bondsmay be less active than the market for ordinary shares, making it harder for the ETF issuer to sell its bond investments. See ASICsinvesting in corporate bondsfor more information about fixed income investments.
Read thePDScarefully, ask questions and consider getting professional advice from a licensedfinancial adviser. Youcan also check recentmarket announcementsfor new information onthe product.
Here are some things toconsider before investing in anETF:
– Is there an active market for the underlying investments? You may be more likely to get a fair price for your ETF units if the underlying assets are traded regularly.
-If thefund usesderivativesthe risks may be higher.
-Make sure youare aware of allthe fees, including buy-sell spreads, as higher fees may reduce your returns.
– Does the price youre about to buy or sell match the NAV quoted by the ETF issuer?
-Make sureyou buying an ETF.Some otherexchange traded productslook like ETFsbut may have much higher risks.
– Are you buying a product on an Australian market?Products traded on a market in another country may not havethe same rules and protections.
-Is theindexbeing tracked provided by a reputable index provider? If youre not sure consider getting advice from yourfinancial adviseror stockbroker.
Micro investing apps allow you to start an investment portfolio of ETFs with small amounts of money. While many types of investments require at least $500 to start, micro investing allows you to access some investments with as little as $1.
You can build your micro investment account balance by rounding up purchases you make using acontactless cardto the nearest dollar (or other set amount) and investing this spare change. You can also build your micro investing account by making regular deposits or by depositing a lump sum amount.
Be sure to understand the fees and charges of micro investing apps. These may include a monthly or percentage fee, depending on your balance, plus fees charged by the ETF providers.
Micro investing makes it quick and easy to start investing, but there are some things to consider before you sign up.
You can start investing with a very small amount of money.
You can start learning about investments without risking too much money.
Micro investing apps generally do not charge brokerage fees (but make sure you know what other fees apply).
Micro investments carry the same risks as similar investments. For example, if you are investing in growth assets, the value can still fluctuate with the market.
Fees can be very high for small balances when compared to other investments.
It will probably take you a long time to grow your investment.
Before you invest in ETFs do your homework.Read the PDS and consider getting advice from a licensed financial adviser. Diversifying your investments between asset classes and product issuers can help control your risks.