An ETF is a financial instrument that provides the investor with an opportunity to get a piece of what is happening in several markets though a single instrument.
A typical ETF is composed of an asset weighting that may use one single asset drawn from a preferred asset class or may use a collection of assets that are pooled from several asset classes. These asset classes include stocks, currency, commodities or indices. So an ETF is built to measure the performance of an asset or a group of assets. So a gold ETF may track the performance of gold, while a metal ETF may track the performance of a basket of several metal assets. It is also important to note that an ETF may be created to track an asset directly or inversely. In other words, an ETF may follow as an asset in such a way that its value rises when the price of the asset being tracked falls (inverse), or may be designed to track an asset as it heads lower (direct).
ETFs and equities share many similar characteristics. They are both bought and sold on the stock exchanges, are priced in the same manner, and also subject to forces of demand and supply, which produce the price volatility and market opportunity inherent in each asset.
Characteristics of ETFs
What are the characteristics of each ETFs?
An ETF is just like a stock in terms of the character of the assets. When you purchase a unit of an ETF you own the asset itself. An ETF is not like a CFD where you buy a contract based on the price of the underlying assets. With an ETF, you own the unit of the fund itself.
Also, the ETF remains yours forever until whenever you decide to treat them off.
ETFs are exchange-traded assets, which means that they can only be bought or sold through a stockbroker on an exchange.
ETF Investing in Australia
As far as ETF investing in Australia is concerned, an investor in Australia can only buy or sell exchange-traded funds that have been listed on the Australian stock exchange. Therefore, only exchange-traded funds that are listed on the Australian securities exchange or the ASX 200 by ETF issuers are eligible for trading by Australian investors. The ETFs listed on Australian exchanges are built to track a variety of assets such as indices or metals.
In Australia, Exchange Traded Funds (ETFs) are classified as part of a broader class of instruments known as Exchange-Traded Products (ETPs), along with Structured Products (SP) and Managed Funds (MF). The ASX offers over one hundred ETPs for trading.
The Australian ETF asset classes are as follows:
These are ETFs that provide the investor with exposure to assets that are found exclusively in the Australian market. These ETFs are made up of assets that pooled from individual listed securities, a sector, a benchmark or the entire index.
Australian sector ETFs provide exposure to certain sectors or groups of stocks that do business in certain industries. For instance, some ETFs provide exposure to technology, banking or energy sectors. Examples of Australian sector ETFs are presented in the table below.
Some ETFs listed on the Australian exchanges provide exposure to international markets. These may offer exposure to particular countries, countries within a single region (e.g. Oceania), or they may be multi-regional. Investors should be aware that investing in international ETFs may come with additional requirements, such as currency exchange or taxation.
It is also possible to invest indirectly into the commodities market using ETFs. These ETFs may provide exposure to individual commodities, or to a commodity index. The trader does not need to take physical possession of the traded items contained in the ETF basket being traded. Also, there are additional requirements and associated risks such as currency fluctuations which may affect the purchase prices of the commodities in question. Remember that commodities are priced in US Dollars, and any fluctuations in the AUD/USD exchange rate may make it cheaper or more expensive to invest in a commodity ETF.
Here are some examples of commodity ETFs for Australian traders:
Fixed Income ETFs
Fixed income ETFs are exchange-traded funds that provide exposure to the yields on government or corporate bonds. These bonds can be the domestic government or corporate bonds in Australia, or they can be international bonds. They can also be Australian territory or state bonds. The advantage of fixed income ETFs is that they are less volatile than others. These are regarded as the most conservative of ETF investments.
Other ETF types include Currency ETFs and Cash ETFs.
Some ETF Buying Tips
Here are some guidelines for those who want to start ETF investing in Australia.
Use Your Goals and Risk Profile to Decide on What ETF to buy
Some ETFs are riskier than others. Therefore, any investors wishing to start investing in Australian ETFs must understand their goals and risk profile, then use these to know what ETFs to buy. Also, it would be best if you looked at the market circumstances. If there is a global economic upheaval, it will make more sense to buy Gold ETFs or fixed-income ETFs than ETFs that provide exposure to equities or risky commodity assets.
Select the Right ETF for the Prevailing Investment Climate
You should select an ETF that has a greater chance of delivering returns in a particular investment climate. Gold is a safe-haven asset that does well when there is a global economic meltdown. In 2020, gold-based ETFs have performed very well as investment money placed a heavy demand on gold and sent prices above $2,000 an ounce. In the same time, index-tracking ETFs plunged and then rose as government stimulus money drove market recovery.
Additional Requirements: Tax and Currency Fluctuations
All ETF investments are taxable. Take time to know what the tax laws around your ETF investments are. Also, note that some ETF investments will require currency exchange. Note when exchange rates will be most favourable.
ETF Investing Mistakes to Avoid
The most common mistakes are:
- Flawed diversification tactics.
- Improper research.
- Trying to trade ETFs that provide exposure in unfamiliar markets.
- Not defining your investment goals.