by Andrew Porter

Created on: August 09, 2009

Exchange Traded Funds or ETFs are an alternative to other kinds of collective investment funds, such as Mutual Funds, Unit Trust, OEICs (Open Ended Investment Company) or investment trusts. ETFs are a relatively new invention, especially in the UK, but in the USA there are many hundreds to choose between and the number of available funds is continuously increasing. ETFs are passively managed, either tracking an index or using some sort of screening algorithm to determine the underlying investments. They have the advantage that, as a consequence, they have far lower fees and total expense ratio (TER). A typical TER might be just 0.2% instead of 1% for an investment trust or as much as 2% for a unit trust or OEIC. As a result of the high fees many other kinds of managed investment actually underperforms the index against which it may be compared, even with a good investment manager. ETFs will never beat the index, but will closely track it.

Exchange Traded Funds are similar to Mutual Funds or Unit Trusts except the price is quoted continuously through the trading day, like investment trusts rather than just once and there is no real manager, because they simply track an index (or other more complex screening algorithm) using computers, therefore have very low annual fee and small bid/offer spread. This makes them very good for short term trading. There is no stamp duty tax charged on the purchase of an ETF, unlike shares or investment trusts and no initial fee (unit trusts and OEICs may charge 5% or more)

The main disadvantage of ETFs over their competition is that you will have exposure to the whole index including badly performing companies or assets, whereas with a managed fund, if the manager is good, you may be able to avoid exposure to the badly performing assets. Managers however do not have a good reputation for justifying their fees and frequently do little more that track the index against which they are being measured.

ETFs are available from any stockbroker in the same way you might buy a share, stock, bond or managed fund. They are also listed in many good financial publications such as the Financial Times.

There are many companies providing ETFS including: iShares PLC; Lyxor ETF; ETFS Securities. ETFs can be used to gain exposure to: Stock indices such as the S&P, Dow, FTSE; Bond indices in many countries; Commodity Prices e.g. Gold, Silver and even House Prices.

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