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Compliance & Regulation, ETFs

ETF investments need proper scrutiny

Investments in exchange-traded funds (ETF) are very popular among SMSF trustees for a variety of reasons, but a proper assessment of these products remains crucial, according to a specialist fund manager.

Head of iShares Australia Jonathan Howie said finding an appropriate ETF in which to invest was not getting any easier either as those types of products continued to grow in number.

“Investors may have different reasons for considering ETFs. Most commonly we see them being used in three main ways: for specific exposure to an asset, such as international equities; to build entire portfolios; or used in a blended approach when combined with actively managed funds,” Howie said.

“From this ever-growing universe it can be difficult to work out the right option to invest in, but the good news is that there are some simple questions that will help investors narrow down the selection.”

Howie has formulated five key questions individuals should ask before they commit to investing in an ETF.

The first question covers what assets are incorporated in the ETF. This can range from Australian equities to international equities to emerging markets.

“Investors should also ensure they are aware of the index that the ETF seeks to track, as there may be multiple indexes to choose from,” Howie warned.

“In addition, they should assess the index methodology, such as whether it includes initial public offerings, how long the index has existed, the predicted tracking error, whether it employs leverage, and the ETF’s method for tracking the index.”

The second issue is to establish the liquidity of an ETF and whether it can be traded when the investor needs to do so.

Howie said factors to consider included market volume, the liquidity of the underlying securities and how the ETF had behaved during times of market stress.

The third question investors should ask pertains to the structure of the ETF.

“A transparent structure minimises unintended risks or costs for investors. Investors should be able to see the assets under management of the ETF, the type of securities it holds, the diversification guidelines, the redemption process and the tax implications,” Howie said.

Investors need to also establish who the ETF provider is and in doing so glean how experienced the manager is and how strong its relationships are with the critical market participants and the regulator.

“Investors should assess the size, scale and track record of the ETF provider, and in particular their risk management processes,” Howie said.

Finally, investors should ask how expensive a particular ETF is. Elements influencing this characteristic include trading costs, transaction costs, expense ratios and tax efficiency.

“Investors should seek institutional-grade ETFs focused on maximising liquidity, tax efficiency and transparency while minimising transaction costs for investors,” Howie suggested.

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