Exchange Traded Funds, commonly abbreviated to ETFs, are a cheap and efficient alternative to investing in managed funds. An ETF will seek to track the performance of an index, usually a stock market index, while charging investors a very low fee compared with a normal unit trust or other fund. Many ETFs can be held in a tax free ISA (if you are a qualifying UK resident). Unlike funds, ETFs are traded openly on stock exchanges: to all intents and purposes, they are just like shares, but instead of investing in a company, you are investing in an index.
A Range of Financial Markets
One of the first – and most successful – ETFs to be launched was the SPDR 500, known colloquially as the Spider, which was listed by State Street Global Advisors on the American Stock Exchange in January 1993. Since then the market for ETF products has mushroomed, and you can now buy ETFs tracking most of the major stock market indexes, as well as many of the minor ones. ETFs are bought and sold every day by both private and professional investors, and represent a cost effective means of investing in a stock market index like the S&P 500.
Exchange Traded Funds can also let you invest in commodity markets. Companies like ETF Securities have listed funds that seek to track commodities futures markets, including individual commodities like oil and gold, and baskets of commodities futures, like agricultural commodities or base metals.
But it goes further than that: Exchange Traded Funds can be bought that represent specific sectors, like real estate or financial services. You can also buy ‘bear’ ETFs that go up when the market is going down (also called ‘inverse’ ETFs). These can be particularly useful if you want to hedge your positions, or would like to go short the market in expectation that it will fall.
The latest trend in the ETF market is for currency ETFs, an alternative to buying direct exposure to currency prices. These ETFs will tend to track the performance of a currency against either the US dollar or a basket of other currencies.
The range of Exchange Traded Funds available in the US is much larger than in Europe, as this is the market where they started, and the take up from investors has been higher. Buying ETFs on US exchanges is exactly like buying shares there. They will be denominated in US dollars and will not be eligible for inclusion in UK ISAs.
ETFs have to try to track an index or other market price, but they will tend to deviate from it over time, partly because of fees, partly because of other issues, like rolling over futures contracts – and partly where these funds are specifically designed to take a different approach – like a ‘smart beta’ ETF.
The Armchair Trader feel that ETFs represent one of the simplest and cheapest ways to invest in indexes and commodities without opening a leveraged CFD trading or spread betting account. Take a look at our broker directory to find a platform that gives you access to ETFs