Investing basics: what is an ETF?
Exchange-traded funds are a simple and cost-effective way of investing in a wide range of asset classes, with both passive and active forms increasingly popular with investors.
Exchange-traded funds are a simple, low-cost way to invest. Instead of going all in on a single stock, ETFs let you buy a basket of stocks (or other assets) that track the performance of a market index.
ETFs are similar to traditional unlisted managed funds in that provide easy access to a range of asset classes including bonds, gold, and infrastructure. But unlike traditional funds, ETFs trade just like a stock on the exchange so you can purchase one with an online stockbroker like CommSec.
ETFs are commonly used get returns similar to a specific market index. For example, you could invest in an ETF that mimic its movements of the S&P/ASX 200.
Let's look under the hood a popular ETF—Vanguard Australian Shares Index ETF (ASX: VAS)—to see this in action.
VAS track the returns of the 300 largest listed Australian companies by market capitalisation—known as the ASX 300.
Today, the top 10 holdings of VAS comprise around 44 per cent of the ETF's net assets. The largest holding in the ETF is Commonwealth Bank of Australia (ASX: CBA), comprising 7.75 per cent of the portfolio. Altura Mining Ltd (ASX: AJM) is the ETF's smallest stock holding, with a 0.00108 per cent share of the total holding. When you buy this ETF, as a unit holder in the fund you are indirectly investing in the 300+ companies it holds.
Vanguard Australian Shares Index ETF | Portfolio holdings
Holdings as at 30 September 2019 Data source: Vanguard Investments
Vanguard charges management fees of 0.10 per cent annually for VAS, making it one of the cheapest broad market ETFs.
Most ETFs are passively managed. Managers who oversee passive ETFs will take a hands-off approach, simply ensuring that their ETFs replicate their designated indices. A manager will not intervene if an index takes a turn for the worse. In other words, the manager is being passive.
State Street's SPDR S&P/ASX 200 Fund (ASX: STW) was the first Australian ETF launched on the ASX back in 2001. Since then, the Australian ETF market has swollen to over $50 billion in funds under management.
Today, there is a wide variety of passive ETFs in the Australian market. There are those which track segments of the local sharemarket like VAS. Then there are others that track global—developed and emerging—markets, such as the S&P500 Index. Newer ETFs now provide exposure to a single commodity or a basket of commodities.
A handful of active ETFs have now become available to investors—including the first such product from Morningstar Investment Management. The Morningstar International Shares Active ETF (ASX: MSTR) listed on the ASX just this week.
Active ETFs are run by a manager or a management team that attempts to outperform their designated index. But outperformance is not guaranteed; sometimes an ETF can do better than its index, but sometimes it can do worse.
The share price for an ETF is based on the net asset value (or NAV) of the underlying stocks the ETF tracks. An ETF typically trades at prices that match this NAV closely. However, ETFs may trade at prices above or below their NAV, as ETFs are subject to supply and demand. These price deviations should, however, be relatively short-lived, as they create arbitrage opportunities which may be exploited by other market participants.
Over coming weeks, we’ll be tackling the issues that matter most to ETF investors. We’ll cover more of the basics—including how ETFs and other types of funds differ, the pros and cons of ETFs and how to buy one via the exchange, or through a micro-investing app.
We’ll also share our highest-rated ETFs across a variety of categories, share our tips for trading ETFs and show investors of all life stages how to assemble portfolios of ETFs to reach their goals.
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