ETF’s – Exchange Traded Funds

Investment Dice

Lowering portfolio costs is an obvious focus for investors, and ETF’s are becoming an increasingly popular investment vehicle to achieve this. Unfortunately the true cost of ETF’s is often more than most investors are led to believe.

ETF’s are a good financial innovation in that they offer the diversity of a managed fund and the convenience of trading on the Australian Stock Exchange (ASX) including instant execution. Most ETF’s are similar to index funds in that they replicate a particular index of shares such as the ASX 200 or ASX 300, however it is also possible to use ETF’s to invest in commodities such as gold.

The downside to trading ETF’s on the ASX is that there is a spread (the gap between what the seller wants to sell for, and the buyer wants to pay) which means you are usually paying slightly more than the asset is worth. This does not happen with managed funds which are traded at a price which all of assets in the fund are worth at the end of the trading day. ETF spreads can sometimes be significant and can be impacted by:

  • Volume – When there is only a little amount of volume being traded, spreads usually become wider.
  • Underlying security – When the shares which the ETF holds have wide spreads, then so too will the ETF.
  • Volatility – When there is a great amount of volatility spreads usually widen due to difficulties in determining the true value of the underlying shares which the ETF holds.
  • Price Discovery – Some ETF’s trade securities in foreign markets which are not open at the same time as the ASX, and in these cases the spreads will usually widen.

From information which the ASX provides, Vanguard Australia has published research showing what were the average spreads for ETF’s for the month of June. Below is a table which combines the relevant spreads and management fees for each product.

Australian equity ETF’s:

International equity ETF’s:

As can be seen the cost of the spread can be significant and should be factored in when investors consider ETF’s for their portfolio.

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