Five questions to ask before investing in ETFs

The use of Exchange Traded Funds (ETFs) has grown significantly in Australia over recent years with a  report released recently by Zenith showed that the ETF sector in Australia has grown 47.5 percent over the last 12 months, from $8.4 billion in July last year, to $12.3 billion at 31 July 2014.

When using ETF’s there are 5 very important questions to address. These are as follows:

What is in the ETF?

 This question looks at the exposure of the ETF – whether to the Australian market or an international one, to a single developed market or emerging market, or to a specific sector or industry.

Investors should also ensure they are aware of the index that the ETF seeks to track, as there may be multiple indexes to choose from.

It is also important to assess the index methodology (such as whether it includes initial public offerings), how long the index has existed, the predicted tracking error, whether it employs leverage, and the ETF’s method for tracking the index.

Can I trade when I need to?

Understanding the real liquidity of the ETF, through both its market volume and the liquidity of the underlying securities, will help investors assess whether the ETF suits their needs.

It includes looking at how the ETF liquidity has reacted during stressed markets and what support the ETF issuer provides investors to achieve the best possible execution when buying and selling ETFs. Issuers with strong relationships with market participants may be better able to foster deep and liquid ETF markets and provide investors and advisors the support to access them.

What is the ETF’s structure?

A transparent structure minimises unintended risks or costs for investors. Investors should be able to see the assets under management of the ETF, the type of securities it holds, the diversification guidelines, the redemption process and the tax implications.

Who are the people behind the ETF?

Those managing the ETF should have experience in the ETF market, in both developing, managing and supporting ETFs as well as in their relationships with market participants, index providers, the stock exchange and the regulator.

Investors should assess the size, scale, and track record of the ETF provider, and in particular their risk management processes.

What does it really cost?

Last but not least, investors should consider the total cost of ownership – ask questions about the expense ratio, trading costs, average spread, transaction costs, and tax efficiency of the ETF.

Investors should seek institutional grade ETFs focussed on maximising liquidity, tax efficiency and transparency while minimising transaction costs for investors.

Nouveau Wealth Management has the necessary expertise to assess whether these investments are right for your portfolio and accesses various providers across many markets in order to obtain diversity and the most appropriate mix.