The future: Worldwide, more than £5trillion is invested in ETFs
Easy, cheap and abundant. That is the lure of Exchange Traded Funds – and investors are increasingly giving in to their appeal.
These investment funds, that typically track the performance of specific stock market indices or the value of precious metals such as gold, are enjoying a meteoric rise with huge sums of money flowing in.
Worldwide, more than £5trillion is invested in them.
Hector McNeil is co-founder of HANetf, which helps create Exchange Traded Funds for financial companies and fund managers.
He says: ‘The sector is enjoying rapid growth and it will continue, fuelled by the product’s greater transparency and lower fees compared to traditional investment funds.’
Nusrath Hussain, ETF specialist at provider Vanguard, says such funds have been investment ‘winners of the Covid-19 crisis’, proving resilient in a market with ‘unprecedented levels of volatility’.
Like any other investment fund, an ETF is made up of different investments. But rather than paying extra for such diversity, they are low cost and can be bought and sold like individual shares.
Most ETFs track an index, such as the FTSE100 or the S&P500 – measuring respectively the performance of the London Stock Exchange’s top 100 companies and the 500 largest companies publicly listed in the US.
Adrian Lowcock, head of personal investing at the investment platform Willis Owen, says: ‘ETFs are often used to access the market as a whole. In volatile market conditions they are popular because many investors just want exposure to the market as opposed to deciding which fund manager will make the most money for them.’
There are many benchmarks and indices an ETF can follow – those tracking equities, bonds, gold or specific market sectors such as technology and healthcare.
Lowcock adds: ‘One of the most popular asset classes at the moment is gold, despite recent falls in the price. ETFs are one of the cheapest and easiest ways to get direct exposure to this precious metal.’
A growing trend this year is ethically orientated ETFs – ones that reinforce positive investment choices that support the environment or society.
These accounted for more than a quarter of money that flowed into ETFs in the third quarter of this year.
Investment manager BlackRock plans to double the number of ethical ETFs it offers in the next few years.
A flurry of ‘robo-advisers’ in the UK has helped fuel the take-up of ETFs. The likes of Nutmeg, Wealthify and Moneyfarm provide investors with portfolios heavily made up of ETFs and other index tracking funds. It is a way of providing diverse investment portfolios at a low cost.
The average cost of an ETF in the UK is around 40p per £100 invested. By comparison an actively managed investment fund is likely to be closer to £1. ETFs can be held inside an Isa, shielding returns from the outstretched arms of the taxman.
James McManus, chief investment officer at Nutmeg, says: ‘I believe ETFs are superior to conventional mutual funds in almost every way.
‘Investors can see exactly what risks they are exposed to; can easily buy and sell them in a liquid marketplace; and they get to keep more of their returns, instead of seeing them leak away in fund management charges.’
Mark Fitzgerald, head of product specialism at Vanguard, agrees. He says: ‘ETFs have helped to democratise investing.
‘Whether you’re a retail investor with £100 to invest, or a pension fund with £100million, you both pay the same percentage fee. That’s not the case with traditional funds, where larger investors usually get sizeable discounts on charges.’
ETFs are usually described as either ‘physical’ or ‘synthetic’. Physical versions invest directly in the bonds or shares that make up an index.
Synthetic versions have the same aim – to track an index – but don’t actually hold the underlying components of an index.
Instead, they use complicated financial instruments such as derivatives to replicate the performance of the index they are tracking. However, some experts are critical of these synthetic funds and say they are riskier than their physical equivalents.
The majority of ETFs are ‘passive’, simply tracking an index, and that is part of the reason they are in demand. But actively managed alternatives exist, too, whereby fund managers attempt to beat an index.
Despite clear benefits, there are also caveats – as with any type of investment.
Lowcock adds: ‘Just because you can invest in something doesn’t mean you should. A lot of ETFs are created for professional investors and should only be considered for experts in their fields.’
He adds: ‘There is an assumption that because ETFs are largely passive, they are not as risky. This is not the case. As with any investment, do your research first.’ Fitzgerald warns against trying to ‘chase the latest trends with niche ETF products’.
He says: ‘Hundreds of ETFs have been launched over the past few years, and not all are suitable for retail investors.
‘We believe those that follow broad, diversified highly liquid markets, such as the FTSE 100 and the S&P500, will give investors a better chance of investment success – if held as part of a balanced portfolio.’
But most experts agree there is no ignoring ETFs right now. McNeil adds: ‘Asset managers without an ETF strategy risk becoming the next failure case study in economics and management classes.’
If you are an investor, there’s a strong chance you are exposed to ETFs already.
But if you haven’t yet joined the party, you are most definitely invited.
MOST POPULAR EXCHANGE TRADED FUNDS
UBS ETF MSCI EMU
What it does: Tracks the performance of the MSCI EMU index – a basket of large and mid-cap stocks trading on stock markets within the European Economic and Monetary Union.
Invesco S&P 500
What it does: Tracks the S&P 500 Index in America, providing exposure to large-cap US companies – with an emphasis on information technology and healthcare stocks.
UBS ETF MSCI Canada
What it does: Tracks the MSCI Canada Index – an index predominantly exposed to financial stocks. The largest component of the index is the e-commerce company Shopify.
Xtrackers MSCI USA
What it does: Provides direct exposure to a portfolio of large and mid-cap US equities, including the likes of Apple, Amazon and Facebook.
Invesco EQQQ NASDAQ-100
What it does: Tracks the NASDAQ-100 index in the US. It is mainly invested in technology stocks with Apple, Microsoft and Amazon the top three holdings.