Exchange Traded Funds

As the name implies an Exchange Traded Fund (ETF) is a fund which trades on an exchange. Historically most ETFs have tracked well known indices by buying all or almost all the stocks or bonds that constitute an index, although today there are many variants. ETFs provide a simple, cost efficient way to gain a diversified exposure to a basket of stocks or bonds without having to go and buy every single one yourself.

Anglo American
Barclays
GlaxoSmithKline
Land Securities
Royal Mail
Sainsbury
Tesco
Vodafone Group
etc…

FTSE 100 Index:
Financial Times Stock
Exchange 100 share index
measures the performance of the 100 largest most actively traded companies listed on the London Stock Exchange.

FTSE 100 Exchange Traded Fund: This would be a single fund trading on an Exchange giving exposure to the Index. It would be made up of the underlying stocks in the Index.

One big difference between a traditional mutual fund and an ETF is that many mutual funds have a portfolio manager who tries to beat the index by selecting fewer stocks than those in the index. They are what the industry calls Active Funds as they are supposed to be actively managed by the portfolio manager who selects stocks which they think are better to own than others. ETFs, however, are traditionally what the industry often calls Passive Funds as they passively own the whole index. There is lots of debate about Active vs Passive – you can Google it!

Based on our research and readings we believe the Passive approach serves investors better in the long term as you are guaranteed to at least save the often hefty fees active managers charge. Additionally, by owning ETFs tracking major indices you inherently gain exposure to the largest, most liquid and tradeable companies in a particular region, country or sector. Companies which do well and become successful and large, which may not be in the index today, will one day and you’d then own those companies. Those which perform poorly and dwindle to become smaller underperforming stocks will leave the index and you’d no longer own them. i.e. there is an inherent positive selection bias, which over many years works in your favour.

“When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients.”
– Warren Buffett, Berkshire Hathaway letter to Shareholders, 25 Feb 2017.

What are the PROs of Equity Index ETFs?

Slide Higher trading volume of underlying stocks 1/6 Slide Higher Free floats of stocks 2/6 Slide Illiquid small and micro-cap stocks are avoided by Index creator or ETF constructor 3/6 Slide Diverse - min number of securities in the index / ETF 4/6 Slide Min market capitalisation rules generally apply 5/6 Slide Generally excludes newly issued securities - minimum length of trading history 6/6

Why should I choose Bond ETFs?

Slide Better market transparency (they don't trade OTC) 1/6 Slide More diversified than holding individual bonds 2/6 Slide The maturing bonds are rolled within the ETF keeping duration constant 3/6 Slide Direct bonds often have high mark-ups for smaller orders 4/6 Slide Usually pay out income monthly 5/6 Slide ETFs are more liquid (Poor liquidity in certain issuers or issuances of bonds) 6/6
“For bond investors, the ETF offers something more: an all-to-all technology to buy and sell the bundle like a stock . . . This is a transformational concept in the bond markets.”

–The Financial Times, December 6, 2016, Rise of bond ETF’s mean little mourning for the middleman.

Some great guides to ETFs can be found here:
London Stock Exchange – ETFs for private investors
CFA Institute Research Foundation – A Comprehensive Guide to Exchange Traded Funds (ETFs)
iShares ETF Due Diligence Guide (for professional UK investors only)

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