Exchange traded funds, or ETFs, have become a very popular instruments for active traders and investors in the US, where they are regularly used as tools by both fund managers and private investors, but here in the UK fewer investors fully understand ETFs or actually use them.
Here at The Armchair Trader we are big fans, however, and here’s why.
ETFs are funds which track an index, for example the FTSE 100 or FTSE 250. They represent a cheap way for investors to ‘own’ the index and see their investment perform very closely in line with the performance of that index. But even if you are an active investor in UK stocks, ETFs can be useful if you want to access overseas markets, including emerging markets.
ETFs have low management fees
ETFs are cheap – the fees for these funds are very low compared to actively managed funds. While there are some fund managers out there who can consistently beat their benchmark index, most, yes most, do not. Yet you will end up paying them heftier fees than an ETF.
The exchange traded fund, on the other hand, has been specifically designed to mirror an index as close as possible. Where there is a tracking error, this usually occurs because of technical costs the ETF has to shoulder – e.g. brokerage costs, changes in futures prices, etc.
ETFs are easy to buy and sell
ETFs are also easy to buy and sell, as if they were a share. You can keep them in your ISA as well. You don’t face the same fees that you would going into and out of mutual funds. These are not complicated products.
Fund management groups and IFAs won’t like ETFs because they represent a much cheaper way to access markets – that’s why we still see so many ‘active’ funds on the buy lists of financial advisors rather than their passive equivalents.
Another value of ETFs is that they let you trade markets that retail investors either cannot access at all or would require a CFD trading account to do so. This includes commodity markets. Here at The Armchair Trader we have traded both oil and silver on both the long side and short side with ETFs.
The range of ETFs listed on the London Stock Exchange is still relatively small compared with the US market, but with over 2000 to chose from in the UK alone, investors have a lot more variety than they had a decade ago. If you can’t find the instrument you are looking for in London, then it is worth considering the US universe, which is massive, but bear in mind you take on some foreign exchange risk in doing so.