What are exchange-traded funds (ETFs)?

Exchange-traded funds (ETFs) are typically passively managed investment funds traded publicly on stock exchanges in the same manner as traditional shares. An increasingly popular product, ETFs combine the benefits and ease of investing in shares with the advantages of mutual fund investing and ready-made diversification of index tracking.

Many ETFs track an index or benchmark, meaning their objective is to replicate the index's or benchmark's performance. ETFs track specific shares, bonds, commodities or currency indices, some of which have a regional focus while others have a sector focus, thus making them ideal for diversifying portfolios.

Geared towards investors and traders who feel they don’t have the time to manage a share portfolio, sufficient capital to achieve a large enough spread of stocks, or the right stock-picking skills, ETFs, like unit trusts, offer an opportunity to invest in third-party vehicles.

ETFs combine the benefits of traditional stock trading, such as intraday pricing and accessibility, with the advantages of fund investments, such as ready-made diversification.

Even though a great variety of ETFs exists, a number of common features can be found. Besides being traded on an exchange, ETFs are typically passively managed, aiming to track rather than outperform a specific index or benchmark, such as stock, bond, commodity or currency indices or baskets.

Trader offers a wide range of ETFs from providers such as iShares, Invesco, SPDR, Lyxor, and many more.

Why trade ETFs?

ETFs offer several advantages for investors compared to unit trusts. Firstly, ETFs are listed and trade all day, unlike unit trusts, which are priced once daily. Secondly, using Satrix as an example, the spread (difference) between the buying and selling prices is often tighter than for many unit trusts.

Versatile, low-cost trading with ETFs

Some ETFs, called inverse or short ETFs, replicate the inverse performance of an index or benchmark, offering investors the chance to benefit from falling prices. Meanwhile, leveraged ETFs offer a daily targeted leverage on the performance of an index, usually around 2:1 or 3:1.

The passive management of ETFs typically results in lower costs than traditional funds. This benefit, combined with the availability of leveraged or inverse tracking of specific indices or benchmarks, makes ETFs ideal for intelligently creating diversified portfolios. The trader can express individual views and preferences, and gain efficient exposure to specific sectors, regions or indices.

Another general feature is that ETF shares trade very close to the net asset value of the underlying fund assets. This is ensured because “authorised participants” – typically large institutions – can create or redeem ETF shares in exchange for the underlying assets, helping to keep prices close to net value through arbitrage. The effect of this is to ensure the ETF share price stays close to the net asset value.

Clients can then track the performance of an ETF through the Trader platform. It is possible to monitor the ETF's price in the price list and use the charting system to identify longer-term price trends and review past performance.

What are exchange-traded commodities (ETCs)?

Exchange-traded commodities (ETCs) are similar to ETFs, but they track the performance of an underlying commodity index rather than a stock market index. ETCs are also traded in the same manner as shares, but provide exposure to a range of commodities and commodity indices, which include energy, agricultural, metals and softs.

The difference is that an ETF index usually tracks a group of companies or a sector, but an ETC is based on an index of a commodity or a basket of commodities. The way the ETC is linked to the underlying commodities depends on the ETC's exposure.  

Like ETFs, ETCs are open-ended shares, but are asset-backed by physical bullion or commodity (futures) contracts.

Because ETCs are open-ended, new ETCs can be created according to demand. Therefore, ETCs generally offer high liquidity supported by the underlying commodities market – either the physical or futures market.

Why trade ETCs?

• Easy access to markets (ETCs are traded as stocks on an exchange)
• Low cost
• High liquidity (often supported by the underlying commodities market)
• Daily transparent pricing