Billions of pounds are invested in exchange traded funds (ETFs) – but what are they and what are the risks?
What is an ETF?
An ETF is traded on a stock exchange and typically follows the rise and falls of a benchmark index, such as the FTSE100 or the rises and falls in prices of bonds, currencies, commodities or other assets.
Management costs are quite low as the funds are passive rather than actively supervised by a fund manager.
More complex ETFs are sometimes termed ‘smart betas’. These tend to sit in tighter, niche markets and follow factors such as dividends, earnings or the spread on investment values.
Are ETFs and other exchange traded products the same?
ETPs or exchange traded products are the collective name for ETFs, exchange traded commodities or currencies and exchange traded notes. Each work in a similar way but are benchmarked against specific sectors.
How accurately do ETFs track an index?
Some are closer than others, but few are perfect. The measure is called ‘tracking error’ and the lower the error margin, the closer the fund is to an index.
What are the returns on ETFs?
Like any other investment, return of the original investment capital is not guaranteed, so investors can lose some or all of their money.
ETFs come as income generating and accumulation products.
Income ETFs pay dividends to investors in cash, while accumulation ETFs pay no dividend and reinvest the cash.
Are ETFs regulated?
It depends. Some are unregulated collective investments (UCITS) and most are based outside the UK, so are not protected by the Financial Services Compensation Scheme, although those with headquarters in Europe or a financial centre such as the Isle of Man or Guernsey will have their own consumer financial safeguards.
How do investors buy into ETFs?
ETFs are traded like stocks and shares, with no minimum holding period. Investors can buy direct, through a stockbroker or an online investment platform.
ETFs can be held in a tax-efficient ISA, SIPP or Qualifying Recognised Overseas Pension Scheme (QROPS).
How much do ETFs cost?
The bid and offer prices can change daily. Buying an ETF generally involves a commission to a stockbroker and actively managed funds will charge a fee.