Amidst one of the most volatile periods in global sharemarket history, exchange traded products were traded by Australian retail investors at record-breaking levels in the first half of 2020.

Investors have tipped $8.3 billion into the exchange traded fund (ETF) sector over the last six months, which is 90% more than the first half of 2019.

As indices worldwide were pummeled by uncertainty, investors took the opportunity to buy in at a lower price, with ETFs offering exposure to Australian equities, Asian equities, gold and oil, among the most popular. This is a stark contrast to the most popular asset class in 2019 – fixed income.

With so much recent interest in the ETF industry, how do investors – particularly newer investors – select the right one for their portfolio?

ETF breakdown

Before we dive in, let’s quickly clarify what an ETF is. ETFs are managed funds that are traded on an exchange, similar to individual shares. Each ETF typically invests in a basket of shares that track an index, such as the S&P/ASX200, which represents the 200 largest companies on the Australian Securities Exchange (ASX).

ETFs have been rising in popularity over the last decade for a number of reasons. Amongst the most significant is that ETFs offer a simple entry point to an entire market if an investor isn’t sure which individual stock they should buy at that time.

Choosing investments like individual stocks can be more time consuming, and the pressure to ‘make the right choice’ can leave investors doing nothing.

However, many would say the ETF market offers endless opportunities too!

There are currently over 243 ETFs available on the Australian sharemarket and this figure continues to grow every month. There were just 95 ETFs available on the market in 2014, reflecting their extraordinary growth in the last 5 years and rising popularity among investors as an efficient way to invest.

The ETFs of today now offer exposure to sectors and emerging investment themes far beyond the realms of the S&P/ASX200, enabling investors to easily diversify their Australian stock portfolio or simply get started in the market.

So, when it comes to assessing the ETF market, it’s crucial to pay close attention to the fees, composition and exposure the product provides and ensure this aligns with your personal wealth goals.

Consider the issuer and trading volumes

Most ETF providers in Australia are well-known institutions with established products and significant funds under management. While the Australian market is highly regulated, it still makes sense for investors to do their due diligence and ensure the provider is credible and stable.

Unlike shares, the trading volume of ETF units is not an accurate indication of liquidity. Many investors mistakenly see a low turnover or trading volumes of ETFs and associate this with low liquidity of the ETF. However, the liquidity of an ETF is associated with its underlying assets, so if those assets are difficult to buy or to sell, then the liquidity characteristics of the ETF will be impacted.

The majority of assets that Australian ETFs invest in are highly liquid, however investors should look closely at the underlying assets in line with their risk tolerance.

Exposure and composition are key

When choosing any investment, one of the most important decisions is the asset class and sector. As a first step, investors should assess their investment goals and review their current portfolio exposure to identify gaps, and opportunities to boost diversification and overall returns.

The majority of Australian investors are overly exposed and reliant on the domestic market, so exploring ETFs with a regional or global focus could provide significant portfolio benefits. Specifically, those products that provide exposure to Asian equities have been high performers over the last six months.

Far beyond just equities, ETFs can also provide exposure to fixed interest, property, cash and commodities, such as gold.

The impact of fees

As with any investment product, fees can have a huge impact on the total return of your investment. The goal of most ETFs is to track an index, but it is important to be aware of fees, which can mean your returns deviate away from the underlying index.

Within the ETF universe, management fees can be as low as 0.04% and as high as 2.0%. There is fierce competition between ETF providers, with fees continuing to reduce, which in turn reduces costs for investors.

When comparing the fees of different ETFs, it’s important to compare apples with apples. In the last few years, we have seen the emergence of specialist and active ETFs. Some incorporate just an element of active asset allocation, moving the underlying exposure slightly away from the benchmark, while other active ETFs are just actively managed funds made available via the sharemarket.

The active element means the fees for these ETFs are generally higher, so cannot be compared on a like-for-like basis with index ETFs. Active ETFs may also include performance fees.

When examining ETF fees, investors will come across the management expense ratio (MER) or indirect cost ratio (ICR). These are both measures of the estimates of the total costs of investing in an ETF. The ICR can make it easy to compare products and usually takes into consideration the management fees, performance fees (if any) and the operating expenses (licensing, compliance, auditing etc.). It’s crucial to do your research around fees and review the Product Disclosure Statement (PDS) before investing. The management fees for the very same ASX200 ETF ranges between 0.07% and 0.19%, and while not significant in the short term, the cost of annual fees adds up over time.

Summary Table

In summary, see below for the important questions to consider when trying to find the right ETF for you.

Does it matter who the ETF issuer is?Does it matter which index your ETF tracks?What is the difference between active and passive ETFs?Can I easily access my cash that's held in an ETF?
Yes – it’s important to do your research on the company issuing the ETF. In particular, be aware of the company’s size, scale, expertise, track record and level of support that it offers to their ETF investors.

It’s recommended novice investors trade with well-known and stable issuers, who have products that are regularly traded.
Yes – each index tracks a different basket of securities, which come with different levels of risks and exposure.

For example, if you are already invested in an ASX200 ETF with BetaShares, there’s little benefit for your portfolio to invest in an ASX200 ETF with iShares – these ultimately track the same thing and don’t offer any diversification!
Active ETFs are actively managed by a fund manager and may deviate significantly from the performance of an index, as the aim is to secure higher returns. Due to this, active ETFs have higher fees.

Passive ETFs simply track an index and therefore have a lower cost.
Yes – ETFs are liquid assets, meaning you can access your cash at anytime the sharemarket is open and you can trade them every day. Just remember, it usually takes two days for trades to settle.

It is important to consider the trade volume and buy/sell spread, as this can indicate there is sufficient trading activity and demand for the ETF.

Want an easy way to compare?

With over 243 ETFs available through the Australian sharemarket, this is an unrealistic number to easily compare and can often be a pain point for investors.

As a Bell Direct client, you can access the Bell Direct ETF Filter which enables investors to simply compare ETFs by performance, fees, asset class, sector, issuer and ICR, and choose the right one for your portfolio.

 

For a limited time, you can join Bell Direct and trade ETFs with no brokerage costs. This special offer is available until 30 September, so click here and take advantage while you still can.