What is an Exchange Traded Fund (ETF)?

An exchange-traded fund, also known as an index tracker, is essentially a portfolio of securities managed by an investment adviser just like a unit trust investment.

Whether you’re saving for retirement, for college expenses or to buy a home, you may want to include exchange-traded funds (ETFs) in your investment portfolio. ETFs are pooled investment vehicles that are generally designed to track a market index, such as the JSE Top 40, S&P 500 or FTSE 100 Index. ETFs trade on the major exchanges like individual stocks, so their prices may vary throughout the day along with the individual securities that comprise the index. The main difference is that an ETF is listed as a company on the stock exchange. This gives individual investors an opportunity to buy and sell a portfolio of stocks through dealing in a single listed share.

ETFs have become increasingly popular over the years particularly with experienced investors and there are thousands of ETFs available for investing. This is because investments can be made and redeemed on the stock exchange at any time of day (when the exchange is open), in exactly the same way that you would buy or sell shares in any other listed company.

Most ETFs are created with the aim of matching the performance of market indices, which are typically well known references for a market, such as the JSE TOP 40.

Diversification

When you buy an investment that is based on an index, you invest in a broad variety of securities. For example, if you invest in an ETF that tracks the JSE Top 40 Index, your money is spread across the 40 companies that comprise the index. This means you also spread the investment risk among all the securities that comprise a particular index. Of course, diversification cannot assure a profit or protect against losses in the fund.

Cost

ETFs generally have lower operating expenses than unit trusts because most ETFs are not actively managed and, therefore, do not incur the internal costs of buying and selling securities. Similar to other investments available in the marketplace, there may be sales commissions associated with the purchase and sale of ETFs.

Tax Efficiency

ETFs do not have annual capital gains distributions that are the result of the active buying and selling of securities in a fund. Instead, any gain is realized when you sell the ETF or there is a positive change in the value of the underlying securities in the index.