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Going all the way with ETFs

Nicki Bourlioufas  |  20 Oct 2016Text size  Decrease  Increase  |  

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Exchange-traded funds (ETFs) come in many different shapes and sizes but it's important to understand some practical ways in which ETFs can be incorporated into investors' portfolios.

Building a portfolio exclusively using ETFs or exchange-traded products (ETPs) is now possible, with exposure to all the major asset classes available through securities listed on the ASX, says Morningstar research analyst Alex Prineas.

"An ETF portfolio is low maintenance, and minimising costs greatly increases your chances of creating good long-term returns," says Prineas.

"In addition to that, it is increasingly possible to get actively managed ETPs so investors are not necessarily forced to have passive investments, though the range of active ETP offerings is pretty modest so far.

"It's certainly a viable way to go, but whether it's advisable depends on the individual's investment strategy, size of the portfolio, level of investment knowledge and so on."

Arian Neiron, managing director, VanEck Australia, says there is a range of ways that ETFs can be employed in portfolio construction. A popular strategy is using ETFs as a core strategy and adding individual positions, or satellites, around that core.

"For example, a core strategy can be achieved by investing in a broad-based ETF," he says.

"For satellites, investors can take positions in sector-specific index funds and/or individual stocks that reflect a current view on markets.

"For example, if an investor thinks the resources sector was going to perform they could put a percentage of the portfolio allocated to satellites into a resources ETF."

Another strategy, strategic asset allocation, is a long-term portfolio strategy that involves setting target allocations for various asset classes and rebalancing portfolios back to the target allocations periodically when the allocations change due to market movements.

"Investors can achieve exposure to each asset class via investing in different ETFs ... Portfolios can easily be rebalanced by selling or buying the required percentage of each ETF via simple ASX trades to return the portfolio to the target allocations," Neiron says.

In contrast, tactical asset allocation is an active portfolio strategy that takes advantage of short-term opportunities to generate trading profits.

So if, for example, an investor thinks banks are undervalued today, investors may decide to allocate some funds to a bank-focused ETF over the shorter term, says Neiron.

"If investors later decide that banks are overvalued and think property is undervalued, investors could switch their tactical asset allocation from banks to another investment in one trade," he says.

Matthew Felsman, private wealth adviser at APP Securities, says some ETFs are short funds, so they are designed to go up when a particular index declines (and vice versa), "providing investors with the opportunity to profit from falling markets".

"Though if markets rise, investors may also face declines in their investment value. But such funds have expanded investment choices and the opportunity for portfolio diversification," he says.

"Conveniently, these types of funds provide all the benefits of short selling, but don't require that you make a direct short sale. This means sophisticated processes like borrowing stock and setting up margin accounts are not required, and certain fees, costs and hassles are avoided.

"In addition, short funds can allow you to hedge exposure to downside risk in your portfolio. This can be a great way to potentially generate returns in volatile markets."

For investors who want to target a particular asset class in their portfolio or investment style, ETFs allow you to get exposure to a specific investment theme without having to take a view on a specific individual stock.

Several thematic ETFs have been launched on the ASX in recent years, such as those aimed at reaping high dividends for investors or ETFs invested in a particular type of asset, such as "quality" or large global companies.

"The exposures available are not just restricted to Australian equities--ETFs offer exposure to currencies, commodities and specific global market sectors as a whole that allow you to take an investment view without much fuss," says Felsman.

"For example, OPEC meetings have fuelled oil market movements, which may provide opportunities in oil exposures ... while investment industry trends have buoyed particular sectors of the market. All of the above can be traded using ETFs."

Cash equitisation or "parking cash" is another useful strategy, says Neiron.

"ETFs can be a good option for investors to make a temporary cash position, such as a superannuation lump sum or proceeds from selling a house, or when transitioning assets between managers."

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Nicki Bourlioufas is a Morningstar contributor.

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