Every investor who wants to earn passive investment income should definitely understand what an Exchange traded fund is.
A public ETF fund manages multiple exchange traded assets and at the same time acts as an issuer of its own shares. One security of an Exchange traded fund includes the entire set of assets managed by the issuing fund. In essence, such a share is a certain exchange pool, the price of which depends on the average value of all assets managed by the fund.
In most cases, such assets include stocks and bonds of other companies. But there are also funds that include exchange-traded commodities, precious metals and energy resources.
Investors who buy shares of Exchange traded fund become co-owners of a share in the total portfolio. In simple words, ETF is a certificate confirming ownership of a whole basket of exchange-traded instruments. However, holders of this certificate do not get rights to individual assets purchased by the fund.
Varieties of Exchange Traded Funds
Today, exchange traded funds have become quite popular instruments, which are present in the portfolios of both beginners and experienced investors. Accordingly, ETFs themselves are created in great variety: their number on the world market is already counted in thousands.
Exchange traded funds can be divided not only by the class of assets they include, but also by economic sectors, business areas and other characteristics.
For example:
– ETFs on stocks and bonds (including government bonds);
– on real estate;
– on banking and financial products;
– on medical and healthcare companies;
– renewable energy.
There are also ETFs that include assets of a specific region and industry. For example:
– US IT sector;
– China’s technology companies;
– companies from developing countries.
In addition, Exchange traded funds can also be categorised by currency:
– ruble – FXMM funds;
– dollar funds – FXIT and FXUS equity funds;
– in euros – bond funds FXRU and FXRB.
Another important criterion for choosing an Exchange traded fund is the management method. According to this characteristic they can be divided into only two categories:
– ETFs with passive management. Such equity funds are also called index funds, because their value depends on the average price of all assets in the portfolio. If the average price of all shares rises by 1%, the fund itself rises by 1%.
– ETFs with active management. In such funds professional traders actively trade on the stock exchange to get income that exceeds the natural growth of the market. Such ETFs occupy only about 2% of the total number of exchange-traded funds.
There are also money market funds, which are characterised by investing in highly liquid short-term instruments. These include Treasury bills, commercial paper, banker’s acceptances and freely tradable certificates of deposit.
Thanks to this variety of Exchange Traded Funds, it is possible to hold a wide range of assets from different industries and regions in your portfolio, even with a small amount of money.
How to choose an exchange-traded fund
There are many different ways to choose the right index fund. You can use both sophisticated analytical systems for professional investors and the simplest tools for beginners.
Search engines
The first thing an investor should do is to identify the ETF category in which they want to invest. After that, you can use an ordinary search engine (Google) to find out which funds are currently available on the market.
Here are some examples of searches based on different criteria:
Selecting ETFs by asset class. You can search for a suitable exchange-traded fund by topic queries: ‘ETF on stocks’, “ETF on precious metals”, “ETF on real estate”, etc.
By country. You can use such queries as ‘ETFs for US stocks’, ‘China ETFs’, ‘European ETFs’ and others.
By sphere of activity. The search is made by such queries as: ‘Medical ETFs’, “Green Energy ETFs”, “Banking ETFs”, etc.
In this way you can get an idea of what ETFs are available on the market, as well as their features.
Detailed analytics
After exploring the basic categorisation information, you can check the key analytics for specific exchange traded investment funds:
– what returns they have delivered in past years;
– what assets they invest in;
– whether they pay dividends and how much;
– what service fees they charge;
– what is the total capitalisation of the fund.
You can find out all this information in one of three ways:
– Visit the issuer’s own website. One fund may issue several (or several dozen) exchange traded funds at once. Of course, it will provide a detailed description for each of them.
– Use specialised analytical resources. For example, ETF.com and ETFdb.com. On such portals you can find information on ETFs from almost any issuer.
– A detailed overview of Exchange traded funds can be found on the broker’s website.
Thanks to such information, an investor will better understand what exactly he is buying and what to expect from a particular fund.
Stock Screener
The principle of buying and selling ETF shares on the exchange is not much different from standard securities trading. Therefore, professional investors use the same analytical tools to select both assets for their portfolio.
Stock screeners are considered to be the most advanced services for monitoring stock markets. A stock screener is a special web service that allows you to sort stocks according to various filters. For example, TradingView, FinViz, Yahoo Finance, Equity and others. It is hard to say which one is better or worse. It all depends on the investor’s specific strategy and personal preferences.
Such platforms help to perform various steps for competent investment in stocks and funds:
– selection of assets by criteria (economic sector, country, trading volume, IPO dates, etc.);
– fundamental analysis (P/E, P/S, P/B ratios, total revenue, etc.);
– technical analysis (graphical indicators, patterns, etc.);
– checking economic, political and financial news that may affect the quotations of individual assets and the market as a whole.
Selecting ETFs using professional screeners is an important part of every successful investor’s work.
Features of investing in Exchange Traded Funds
Although ETFs trade on par with regular stocks, they have some features to consider.
Value
The value of an exchange-traded asset is an important criterion that investors pay attention to. In order to build a diversified portfolio when trading stocks, you need to have a fairly large amount of money to invest. But thanks to ETF you can distribute your finances in different directions, having at your disposal a very small amount of money. And a share of the fund can be much cheaper than any asset under its management.
Dividends
ETFs often include shares on which dividends are paid. Accordingly, the fund manager may choose one of two strategies to distribute them to investors.
The first strategy is the proportional payment of dividends to the holders of the fund’s shares. In this case, two basic indicators are taken for calculation:
– The number of shares of a single company in the fund’s portfolio. For example, 100 shares of company ‘A’.
– The total number of shares in the fund, for example, 1000. That is, one exchange-traded ETF contains 0.1 shares of company ‘A’.
If at the end of the reporting period the company ‘A’ pays dividends in the amount of 100 dollars per share, the co-owner of the portfolio will receive 0.1 part of this income – 10 dollars.
But in the world practice the second strategy is more widespread, when the Exchange traded fund reinvests dividends itself. That is, the funds received from the issuers of shares are used to buy new securities. As a result, the capitalisation of the fund and the value of its portfolio increases. If we take the same example with Company A, after reinvestment, the value of each ETF share will increase by $10.
You can find out how a particular fund disposes of dividends on its website, as well as from the broker or analytical portals.
Conclusion
Exchange traded fund is a convenient tool for those investors who want to invest money profitably, but do not have enough experience or time to build a profitable portfolio on their own. Beginners can use the funds to take their first steps in investing and enter the market with minimal risks. And experienced investors use ETFs to spread their finances across a large number of assets, without having to analyse each one individually.
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