Exchange Traded Funds (ETFs) have become increasingly popular in Australia as an investment option.They offer a simple and convenient way to invest in a diversified portfolio of assets at a relatively low cost. Let’s take a closer look at investing in ETFs in Australia, exploring how they work, the categories on offer, whether you should consider investing in an ETF.

How do Exchange Traded Funds work?

An Exchange Traded Fund (ETF) is a type of investment fund that is traded on a stock exchange, just like shares in an individual company. You can buy and sell ETFs at any time during the trading hours of a stock exchange, and the unit price can change throughout the day.

ETFs in Australia typically track a specific index, such as the S&P/ASX 200 Index, which represents the top 200 companies listed on the Australian Securities Exchange (ASX). This means that by investing in an ETF, you can gain exposure to a broad range of assets, such as stocks, bonds, and commodities, with a single trade. This can be a more efficient and cost-effective way to invest compared to buying individual stocks or units in managed funds, as transaction costs are generally lower.

An ETF may own thousands of stocks across a range of industries, or focus on a particular sector, like energy or technology. They can also span multiple geographic locations. Some funds, for example, may only focus on Australian-held assets, while others may invest in the largest global energy companies listed on a number of overseas stock exchanges.

What are the different categories of ETF?

There are a variety of different ETFs available to investors in Australia that can be used for income generation, capital appreciation, or portfolio diversification. The most common ETFs in the market include:

Equity ETFs

These funds invest in a diversified portfolio of stocks or shares of companies listed on a stock exchange. Most equity ETFs aimto track the performance of a particular market index, such as the ASX 200 or S&P 500. Equity ETFs offer investors broad exposure to the stock market, the chance to invest across the largest companies (as measured by market capitalisation), and the opportunity to participate in the growth of individual companies and the overall market simultaneously.

Bond ETFs

These funds invest in fixed income securities, such as bonds issued by governments or corporations. The primary aim of bond ETFs is to provide a regular income stream to investors with the potential for some capital growth. The income is generated through interest payments made on the bonds held in the fund. Bond ETFs are often used by investors to diversify their portfolios and reduce the overall risk profile.

Commodity ETFs

Commodity ETFs invest in physical commodities such as gold, silver, or oil. The primary aim of commodity ETFs is to provide exposure to the price movements of those underlying commodities. Commodity ETFs offer investors the opportunity to invest in tangible assets and potentially hedge against inflation.

Currency ETFs

Currency ETFs offer investors the opportunity to profit from changes in various exchange rates and to hedge against currency risk. They are suitable for investors with a specific interest in currency markets and those looking to diversify their portfolios.

Industry/Sector ETFs

Industry or sector ETFs focus on a specific sector or industry on the stock exchange. For example, an energy-focused ETF will only consist of shares in energy companies.

What are the benefits of investing with ETFs?

One of the attractions of investing in ETFs is their relatively low cost. Unlike actively managed funds, ETFs are often passively managed, meaning they simply replicate an underlying index with fewer buy and sell decisions make by the manager. This may translate into lower fees for investors. although an actively managed fund may have higher fees ).

Another benefit of an ETF investment is their flexibility. They can be used in a variety of ways to meet your investment goals and risk tolerance. For example, you can invest in ETFs that track a specific market sector, such as technology or healthcare, or you can invest in ETFs that track a specific asset class, such as bonds or commodities. Essentially, this allows you to tailor your investment portfolio to meet your specific goals without the risks associated with investing in individual companies.

What are the potential risks of ETFs?

While ETFs have become popular investment vehicles, it’s important to remember that every investment type can have its drawbacks. For ETFs, there are the obvious market and investment risks (interest rate fluctuations, economic downturns, etc) and there also the not-so-obvious risks. For example, because ETFs are listed on a stock exchange, prices can fluctuate from the underlying value in an extremely volatile market.

ETFs invested in bonds are also exposed to credit risk if a bond issuer defaults on its debt obligations, the value of the ETF will decline, causing a loss in investment.

Finally, even though ETFs generally track the performance of an underlying index, it's possible for the ETF to not perform exactly as the index does. This is known as a tracking error, which can result in an underperforming ETF in comparison to the index.

Ready to get started with Exchange Traded Funds In Australia?

Whether you're a seasoned investor or just starting out, ETFs can be a valuable addition to your investment portfolio. However, it's also important to consider factors such as the underlying index, management fees (which vary between passive and actively managed ETFs), and diversification when considering which ETF to invest in. By conducting research and identifying the product best suited to your investment needs, you improve your changes or increasing your net asset value.

This article contains information of a general nature only, and should not be regarded as advice, either general or personal. Anybody considering investing in ETFs should seek professional financial and legal advice prior to making investment decisions.