Exchange traded funds (ETFs) can provide you with a simple and affordable way to invest in multiple companies, bonds or other investment types – all in one go. If you’re thinking of investing in an ETF, this guide may give you a better understanding of how ETFs work and help you to decide if ETFs are right for you.
An ETF is an investment fund that can combine a range of securities – like shares, bonds, commodities, or a mix of assets – all into one investment. In addition to a range of asset classes, some ETFs offer investors access to different markets. For example, you can purchase units in an ETF that’s listed on the NZX or ASX but invests in international shares.
Like managed funds, investors pool money together to invest in a fund managed by an independent manager. But unlike managed funds, ETFs trade on the share market just like shares. This means ETFs can be traded whenever the share market is open and there are buyers and sellers in the market. Settlement will generally occur two working days after the trade date.
It’s important to understand that when you invest in an ETF, you don’t own the securities the ETF invests in – you’re simply buying units in a fund.
Broadly speaking, there are two approaches to managing a fund: passive management and active management.
ETFs are generally passively managed, which means they track a market index (such as the NZX50, ASX200 or S&P500) with the aim of replicating the performance of that index.
Let's take the example of an ETF that tracks an index containing the 10 largest companies on a stock exchange. The ETF holds shares in each of the companies in proportion to the index, so if the price of the shares in each of the companies goes up, the value of the ETF as a whole should go up as well, and vice versa.
On the other hand, ETFs that are actively managed are picked by individuals, rather than track an index. The securities are chosen by a fund manager according to a particular strategy that generally aims to outperform the market.
Actively-managed ETFs can be more risky than passively-managed ETFs as they depend on the skills of the individual fund manager selecting securities, rather than simply tracking a market. They can also incur higher fees as more management time is required for active investing.
Because ETFs trade on the share market, their value is determined by supply and demand, as well as factors like the economy and the performance of its underlying securities or assets. Like shares, they are bought and sold at the market-determined value, which can change throughout the day.
To gauge whether the market value is a fair price, you can look at what's called a Net Tangible Assets (NTA).
The NTA is an important calculation that provides what is considered the actual value of the underlying assets for each unit of an ETF. The NTA can be found along with other pricing information about an ETF. By looking at the NTA, an investor can generally see if the ETF is trading above the actual value (called 'trading at a premium') or below actual value (called 'trading at a discount').
How an ETF makes money depends on the ETF, but generally, there are three ways you may be able to get returns from ETFs:
Distributions, or pay-outs, from dividends and interest are usually paid quarterly, semi-annually or yearly – depending on the ETF – and any fund management fees are deducted before distributions are made. Every ETF is different so it’s important to read the ETF’s product disclosure statement for more details.
You can organise to have your ETF distributions reinvested or paid out to a bank account that you select.
The risks may vary from fund to fund, but here are some of the risks ETFs could expose investors to:
Before you invest, always read the relevant product disclosure statement (PDS) to ensure you understand any further risks.
As ETFs are a cross between managed funds and share trading, there are generally two types of fees:
It’s important to include these fees when working out your investment strategy and potential returns.
Whether you're interested in investing in ETFs on the NZX or ASX, we can help you get started. Find out more.
If you aren't already an ASB Securities client, the first step is to join ASB Securities online.
If you’re an ASB Securities client, you can invest in ETFs straight away. For ETFs listed on:
You can also view market pricing for New Zealand and Australian ETFs in Online Share Trading.
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