|Exchange Traded Funds are a newer
form of pooled investment. To some extent they combine the best
features of Investment Trusts and Unit Trusts.
Best to take an example.......
'iShares FTSE 100' is the name of an ETF
that tracks the FTSE 100. It is listed in the share pages of the Financial
Times under 'Exchange Traded Funds', immediately after 'Investment
Companies'. You can also find it on any of the share quote websites
under the code ISF. 'iShares' is the brand name used by Barclays as
the world's leading provider of ETFs.
You can buy and sell an ETF through your broker in
exactly the same way as you buy or sell a share or an investment
trust. Today ISF is quoted as: 452.75 bid, 453 offered. If you bought
1,000 it would cost £4,543 + broker's commission and it would appear
on your broker statement until the time comes for you to sell it.
Just like an ordinary share.
How does it work?
The manager of ISF holds a basket of shares which mimics the constituents
of the FTSE 100, just like any tracker. He collects the dividends
on these shares and periodically pays them out to shareholders after
deducting his management charges. For ISF these are 0.5%.- competitive
with other low cost trackers.
The clever twist is what the manager does when shares
in the ETF are bought and sold. If buyers and sellers are matched
- fine. But if not, (if there is a single big institutional buy
order, e.g.) the manager may directly buy the underlying basket
of shares in the market (or, more usually, off-market direct from
another institution) and issue new ETF shares to the buyers. This
process not only ensures liquidity (or at least the same liquidity
as the underlying shares), but also means the price of the ETF closely
tracks the price of the underlying basket of shares (otherwise an
institution could arbitrage the difference).
An ETF marries some of the best features of investment trusts and
- There is a continuous price quotation (unlike
unit trusts, where the price is set once per day, which allowed
some market timing scams in the US back in 2004).
- There is no discount
to worry about (unlike investment trusts).
- There is no stamp duty (although the fund may pay
stamp duty on its own share purchases)
- Administration costs are lower than for a unit
trust tracker (no monthly statements to you , for example) so
charges should be low
- There are no hidden charges.
- You pay broker's commission and the buy/sell
- And because charges should be low does not
mean they are. In the US, where ETFs are much more accepted, charges
have begun to go up.
Most ETFs are run offshore outside the UK regulatory system. So
they are not covered by the UK compensatory regime.
Just because an ETF should be low cost does
not mean it is. In the US you can buy Funds of ETFs, with
a layer of added costs sumilar to that for an actively-managed fund
thus negating the whole point of an ETF!
There is now a wide range of ETFs covering many specialist
areas. This is good, but you have to be careful you are investing
in what you expect.
Finally, it must be admitted that they have not yet
been battle-tested as widely-used products for the retail investor.
Maybe there is a weakness that would be revealed if a sponsor collapses,
or if Black Monday repeats, or whatever. So you don't want to put
all your eggs in this one basket. But these are fundamentally simple
products, and should do what it says on the tin.