ETFs offer easy entry to exciting markets

By Neville Bennett

Friday 16th July 2004

The controversy over the high cost of managed share funds may lead to consideration of ETFs (exchange-traded funds), which offer low costs (usually 0.75%) and entry to different and exciting markets.

ETFs are essentially index funds that trade like shares on major stock exchanges. They were launched in the US in 1994 and now have a market value of $US150 billion only a fraction of the $US7.5 trillion held in funds but growing quickly.

They are attractive because they are low-cost passive funds that track various indices. Their attractions also include high liquidity.

They trade continuously during market hours and allow investors to lock in a price at any moment. Other funds in contrast are priced once a day using the closing price of their stocks.

ETFs offer wonderful diversification. Investors can buy products designated by industry or country, growth or income. Many opt for an ETF that tracks Wall Street's most important index, the Standard & Poor's 500. The advantage is that fees have been honed down to as little as 0.09%.

The S&P500 iShare is a transparent investment; its price is quoted throughout the day and investors can also follow it on the futures market.

It is necessary to keep an eye on brokerage as this can significantly increase costs for investors, especially if they trade or switch frequently. In some cases ETFs will not be cheaper than mutuals.

ETFs are attractive to do-it-yourself investors who don't want to do a lot of research. They pick an index and buy in. Institutions are doing the same to ensure they come as close as possible to staying with the index. For non-institutional investors, ETFs are an excellent way of getting exposure to sectors such as financials, energy, commodities and pharmaceuticals. Morningstar has just introduced ETFs that mirror its well-known special indices.

Barclays International offers funds that track the main indices in markets such as Brazil or Malaysia. The adventurous investor can take some interesting punts. For example, you might be bullish about Europe, so you go long on Europe 350, but at the same time feel bearish about Japan, so you short iShares Japan. Morgan Stanley also offers a lot of country plays.

There are already 126 open-ended ETFs in the US and it is possible their role will increase as people cotton on to their use in retirement and estate planning.

The estate management side is important. It is unlikely other funds will have a 50-year horizon or be able to keep up with the S&P over 50 years. But an iShare will do that indefinitely at low cost.

Another innovation is offered by Redmayne-Bently, of Leeds. Its Plan Bee is a new low-cost monthly investment scheme designed to let smaller investors share in growth of the FTSE 100, which rose 13.6% last year. By making regular contributions, an investor should be able to accumulate a solid amount over the years without having to make hard decisions on individual companies.

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