Five questions to ask before investing in ETFs: iShares

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With the popularity of Exchange Traded Funds (ETFs) growing amongst Australian investors, their biggest challenge can be in choosing between different ETFs that may look very similar, and choosing the right ones for them, says Jonathan Howie, head of iShares Australia.

Jonathan Howie

“A report released this week by Zenith showed that the ETF sector in Australia has grown 47.5 percent over the last 12 months, from $8.4 billion in July last year, to $12.3 billion at 31 July 2014.

“From this ever-growing universe, it can be difficult to work out the right option to invest in, but the good news is that there are some simple questions that will help investors narrow down the selection.

“Investors may have different reasons for considering ETFs.  Most commonly, we see them being used in three main ways: for specific exposure to an asset such as international equities; to build entire portfolios; or used in a blended approach when combined with actively managed funds.

“Regardless of their reasons, five key questions can help investors make the right choice,” Mr Howie says.

The five questions are:

What is in the ETF?

Mr Howie says this question looks at the exposure of the ETF – whether to the Australian market or an international one, to a single developed market or emerging market, or to a specific sector or industry.

“Investors should also ensure they are aware of the index that the ETF seeks to track, as there may be multiple indexes to choose from.

“In addition, they should assess the index methodology (such as whether it includes initial public offerings), how long the index has existed, the predicted tracking error, whether it employs leverage, and the ETF’s method for tracking the index.”

Can I trade when I need to?

Understanding the real liquidity of the ETF, through both its market volume and the liquidity of the underlying securities, will help investors assess whether the ETF suits their needs, says Mr Howie.

It includes looking at how the ETF liquidity has reacted during stressed markets and what support the ETF issuer provides investors to achieve the best possible execution when buying and selling ETFs. Issuers with strong relationships with market participants may be better able to foster deep and liquid ETF markets and provide investors and advisors the support to access them.

What is the ETF’s structure?

Mr Howie says this area is often overlooked by investors, but is critical.

“A transparent structure minimises unintended risks or costs for investors.  Investors should be able to see the assets under management of the ETF, the type of securities it holds, the diversification guidelines, the redemption process and the tax implications.”

Who are the people behind the ETF?

Those managing the ETF should have experience in the ETF market, in both developing, managing and supporting ETFs as well as in their relationships with market participants, index providers, the stock exchange and the regulator.

“Investors should assess the size, scale, and track record of the ETF provider, and in particular their risk management processes,” Mr Howie says.

What does it really cost?

Last but not least, investors should consider the total cost of ownership – ask questions about the expense ratio, trading costs, average spread, transaction costs, and tax efficiency of the ETF.

“Investors should seek institutional grade ETFs focussed on maximising liquidity, tax efficiency and transparency while minimising transaction costs for investors,” says Mr Howie.

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12 September 2014