5 reasons to own ETFs
In the 30 years since the creation of the first Exchange Traded Fund (ETF), these products have grown exponentially both in size and the range of options available. ETF investors today can invest in almost any location, asset class, or even sector. All this comes at a low cost, and with the simplicity of a single trade on their local stock exchange. It’s no wonder then, that the total assets under management of ETFs globally was over US$4.5 trillion in 2018. Here are five reasons to consider ETFs as part of your investment strategy.
1. Invest in what you know – but what if investing in what you know burns a hole in your pocket?
Recent financial research from Vanguard found Australians held 66.5% of their portfolios in Australian shares. When you invest in the Australian sharemarket, you’re basically buying financial stocks and miners. The financial sector makes up 30% of the domestic market, while resources make up 25%.
Even professional investors fall victim to home bias. In a study on fund managers’ views on prospects for international markets, fund managers from the US, UK, Europe and Japan show a significant relative optimism towards their home equity market.
Home bias can leave portfolios with heavy exposure to similar risks and investment cycles, which can mean a greater chance of loss. It can also mean missing out on potentially better opportunities elsewhere.
The key to overcoming home bias is diversification. Diversification is all about choosing assets that move differently. Diversification across assets, geographies, economic cycles and duration can improve the risk profile of a portfolio while at the same time help to generate better returns.
With ETFs, diversification is easier than ever.
2. Pure exposure & liquidity
With an ETF, you don’t run the risk of a change in investment style as you could with a traditional fund manager, so you get dependable market exposure. Most ETFs are liquid investments and while investors should steer clear of buying or selling on the open, at other times, market makers help to provide liquidity to the market.
3. Avoiding and understanding cash drag
Most investors hold some of their portfolios in cash. Since markets are higher most of the time, cash usually acts as a drag on performance. To avoid this cash-drag, investors can invest in an ETF until they need to put the money to work.
Cash-drag can also work negatively in an ETF. While dividends can typically be paid monthly, quarterly or half yearly, it means that the ETF does not replicate the accumulation index and this dividend - while waiting to be paid - does not yield market returns. This cash drag is a larger consideration for higher yielding ETFs.
For most investors, costs are an important consideration. Many studies have shown underperformance in the market related to transaction costs and expenses. As transaction costs and fees fall, more capital is available to harness the power of compounding returns. ETFs have a lower cost structure than traditional managed funds and have helped pushed management fees lower for investments.
5. Be smart
Many fund managers end up hugging an index which means that portfolios are biased towards market capitalisation or size. This bias makes little sense as an investment style and there are better ways of evaluating the size of positions. Smart beta ETFs enable investments to be adjusted according to several return-enhancing factors such as earnings momentum, price momentum, quality, ESG and management strength.
You can trade in a wide range of ETFs to get exposure to the Australian sharemarket, international stockmarkets, commodities, currencies, sectors, styles and themes. With so many options out there, it’s important to know that some ETFs are more complex and riskier than others. As always, do your homework and read the Product Disclosure Statement to find out how closely ETFs can replicate your goal.
In the end, most of us can’t be great in all things. ETFs increase the number of options available to investors to create more optimal portfolios.
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An experienced presenter and Australian equities strategist with over 13 years experience. Passionate about stock selection strategies and combining fundamental and technical analysis for trading and investment decisions.