Exchange Traded Funds (ETF)

Similarly to equity, and as the name suggests, exchange traded funds, or ETFs, are traded on a stock exchange. They are collective investment schemes with underlying investments into various securities, often an index, but potentially equities, bonds, commodities and various other asset classes.

An ETF tracking the S&P 500 index, for example, will purchase holdings in the US companies that make up that index, seeking to replicate the movements of the index in the market.

As they are traded on an exchange, the price of an ETF is changeable depending on market dynamics such as supply and demand. Similarly to a closed-ended fund, there are a limited number of shares available, however the manager of an ETF can create new shares if demand exists; likewise, they can also redeem blocks of shares if they believe this is necessary.

ETFs are generally cheaper than traditional open-ended collective investment schemes, as most are managed passively, tracking the performance of an index or benchmark. Managers of ETFs therefore do not charge high annual management charges to operate the funds. Actively managed ETFs are available, however these have higher charges as the fund manager is more involved in the selection of assets for their portfolio.

ETFs can also be more tax-efficient than open-ended funds.

There has been a significant move towards passive investing in recent years, with ETFs rising in popularity year on year. The low cost and relative simplicity of ETFs make them an attractive way of adding diversification to a portfolio. The exchange traded nature of ETFs can lead to some downsides, however, with trading and price dependent on availability of shares in the market. This can mean that sometimes the share price is less than the value of the assets the fund holds; this is called trading at a discount. Finally, though cheaper than active funds, there may be additional costs involved with trading in ETFs, such as commission for a stockbroker to deal in the purchase and sale of shares in the market.