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What is an ETF?

By AMP Capital

Exchange traded funds (ETFs) have become one of the fastest growing financial instruments in the world. ETFs are similar to traditional managed funds but traded just like a share on the stock exchange. They are an easy to use, liquid and cost-effective way to diversify investments.

There are a number of features that make ETFs unique.

Traded on the stock exchange
ETFs, firstly, are traded on the ASX and can be bought and sold at any time of the day using a broker trading account. Each ETF is identified by its own ticker code. Investors can quickly adjust their portfolio, efficiently turning a cash position into an equity position.

Passively managed index exposure
ETFs are generally passively invested: they aim to track the performance of an index, such as the S&P/ASX200, and deliver investors the index return, less any fees. ETFs are available for domestic and international equity indexes, sectors, fixed income and currencies.

Open ended
ETFs are liquid – easy to buy and sell -- because they can create more units to meet demand, should investor demand exceed supply. Similarly, units can also be cancelled should supply exceed demand.

Transparent pricing
The market price of an ETF – the actual price that you can buy and sell the ETF – generally tracks the ETF’s net asset value (NAV), the market value of the ETF’s holdings.

The NAV is calculated daily. But because ETFs are traded throughout the day, most issuers of ETFs also produce an iNAV (indicative net asset value), an intra-day and real-time indication of net asset value.

regulated unit trust structure

ETFs are generally registered managed investment schemes and are therefore subject to all the usual requirements for registered schemes under the Corporations Act.

Market makers

ETFs issuers contract ‘market makers’ – third parties to keep the market price close to the NAV.

Investor benefits
ETFs provide investors with a number of benefits:

Liquidity and transparency: They can be bought and sold through the day at live pricing through a broker
Simplicity: ETFs don’t require detailed paper work. Investors need an existing share brokerage account to trade ETFs. Unlike managed funds that require investors to fill in forms to make an investment, no additional paperwork is required for an ETF.
Low cost: Many ETFs are typically cost less than traditional managed funds because they are passively managed and avoid the expense of active management fees.
Tax efficiencies: ETFs can deliver tax benefits because of their low turnover.
Diversification: ETFs allow investors access a diversified portfolio of holdings in equities, fixed income and currencies in just one trade.
No minimum investments: While many managed funds require investors to invest at least a certain amount in the fund, with ETFs do not have minimum investment requirements. Investors can trade smaller amounts as dictated by capacity and investment strategy.

However, like all investments, ETFs involve risks including that the value of the ETF’s underlying investment may fall (market risk), fluctuations in the value of the Australian dollar may affect the ETFs value where underlying investments are international (currency risk), there may not be a liquid market for the ETF (liquidity risk), and that ETFs can experience mispricing and divergence from NAV.

Active ETFs – a new type of ETF
One of the biggest trends is the emergence of ‘Active ETFs’. An Active ETF effectively allows you to buy a typical actively managed fund on the stock exchange, just like a share.

Unlike traditional ETFs, which are typically passively managed and aim to track a particular benchmark or index, active ETFs are proactively managed and aim to outperform a benchmark or index.

Active ETFs deliver all the benefits of an ETF – protection, ease of use, liquidity – with the additional benefit of access to potential outperformance through active management.
 

While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in it. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. Before making any investment decisions you should consider the appropriateness of the information, and seek professional advice having regard to your own circumstances.

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Important notes

While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455)  (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

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