How I Choose ETFs
ETFs or Exchange Traded Funds are managed funds that are listed on the stock exchange, making it easy for investors to buy and sell from a share brokerage account.
In almost every way you think, ETFs exploded onto the scene.
There are now dozens of ETFs in Australia taking the headache (and paperwork) out of investing in funds managed by professionals (or their computers).
To buy an ETF all you need is a brokerage account — no longer do you need to fill in a lengthy disclosure document just to invest in a fund managed by a professional firm.
However, what many investors don’t know is an ETF is really just the wrapper around a managed fund.
What I mean is, most people think ETFs are the same as ‘index funds’. That’s wrong. Many ‘ETFs’ use strategies that can do lots more than, say, follow the ASX 200 index.
I explain ETFs in detail in this video:
Not All ETFs Are Created Equal
As I said above, ETFs have exploded onto the scene.
Bloomberg’s Rachel Evans and Carolina Wilson reported in September 2018 that ETFs can account for as much as 40% of all US market trading!
“Trading in ETFs usually accounts for about a quarter of the daily volume in U.S. stock markets, but that can leap to nearly 40 percent on some days,” the authors wrote.
Given their popularity amongst low-cost index and ‘smart beta’ providers, a meaningful amount of money is now invested via ETFs here in Australia.
But here’s the thing — ETFs are not risk free.
And I think Australia could be nearing a tipping point. Meaning, there are now so many funds to choose from that there’s almost too many.
The thing about ETFs is that they need to reach scale to be successful for the fund manager. That’s because it costs a lot of money to start an ETF and keep it running. They can be very lucrative for fund managers once they reach, say, $200 million invested — but some struggle to make it to $200 million. Those that can’t reach scale could be closed.
What I Look For In ETFs
When I’m assessing an ETF, I’ll typically look for a few things (I learned a lot of this during my brief time working in a funds management research business):
- Size (yes, it matters) – this effects almost everything, from liquidity to profitability to costs to spreads.
- Strategy – underlying ETF strategies focused on large markets and transparent investments translate into ‘easier for a funds management company to operate’
- Liquidity – when the fund/ETF is investing in small companies, shallow bond markets, real assets (like infrastructure, property, etc.) I think investors should to be doubly-careful
- The fund manager itself — easily overlooked, investors should ask themselves if the funds management business that’s responsible for the ETF could sustain the financial impact of a fall in ETF demand (e.g. during a market crash). Consider how large and established the ETF issuer is, how many funds they have, their focus areas (i.e. is their ETF business important to them?) and how likely it is that the fund would be closed.
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My #1 ETF
I recently released the name of my #1 ETF to Rask Invest members.
I can’t give away much detail (that’s the benefit of joining Rask Invest — to receive my #1 ideas, an entire wealth strategy, invites to events and loads more).
Nonetheless, the ETF I’ve chosen as my #1 idea has well over a billion dollars invested in the strategy and it is operated by an established ETF provider.
In addition, it aligns with my investment philosophy and… here’s the best part… I expect the strategy to outperform its benchmark for many years.
That’s right, the ETF follows a rules-based strategy that I think holds lots of promise for long-term investors like me. I think it’s especially appealing for those who like a ‘no fuss’ way to invest money and diversify their portfolio with just a few clicks of a button.
Of course, there’s no guarantee it will perform well in the future. But I think the odds are stacked in my favour — why else would I buy into the ETF using my own money for the Rask Invest model portfolio!?
Cheers to our financial futures!
Lead Adviser, Rask Invest
Disclaimer: This article contains general financial advice only. The information does not take into account your needs, goals or objectives. Please see The Rask Group’s full disclaimer below.