INVESTOR discussions on mutual funds and unit trust Investments invariably lead to additional questions about exchange traded funds (ETFs). Hence, this article will focus on addressing commonly asked questions concerning ETFs.

What is an ETF? According to the website Investopedia, “it is a marketable security that tracks an index, a commodity, bonds or a basket of assets like an index fund.” For example, an individual could invest in an ETF which tracks the S&P 500. That is, the ETF would contain all the stocks of the S&P 500 and would therefore increase in value (if the S&P 500 went up) or decrease in value if the S&P 500 went down. In simpler terms, it would mirror the movement of the S&P 500 in this example.

This type of investment option is becoming more popular with clients seeking to diversify their portfolio while participating in the international stock market. ETFs typically have higher daily liquidity and lower fees than other investments, making them an attractive alternative for individual investors.

They have no restrictions on the number of shares one can purchase and trade on the stock exchange. They are designed to track the performance of funds and their underlying index on stock markets internationally. A very savvy investor may take gains throughout the day and jump back in if they so desire. Investors may earn interest and dividend payments within a day and exit the fund if they so wish.

Most ETF investors are interested in the foreign markets, emerging markets and tracking the stock and currency movements worldwide. Remember ETFs can hold assets such as stocks, commodities, or bonds, and trade close to their net asset value over the course of one trading day. Clients in Jamaica tend to have strong appetites for equity based ETFs in the international markets.

Here are some of the biggest advantages of investing in ETFs. Firstly, they provide investors with access to global markets and a wide range of asset classes allowing investors to diversify their portfolios. Secondly, they are able to achieve these levels of diversification with comparatively small investment minimums which are very attractive to young and savvy investors. Finally, competitive prices, flexibility and liquidity, transparency and no sales charges are additional benefits derived from investing in ETFs.

Flexibility

Most investors are comforted by the high level of liquidity in the market and the inherent flexibility in buying and selling at any time during any given trading day, unlike mutual funds and unit trust investments, which can only be traded at the end of the trading day.

Some ETFs invest in commodities, currencies, indices, and various other investments all of which allow for easy trading and redemptions.

ETFs offer investors many benefits but there are also a few disadvantages. One such disadvantage is that ETFs are sometimes restricted to investing in larger companies’ stocks to enhance liquidity, however, this can limit opportunities present in smaller company stocks..

There is also a general lowering of dividend yields as a result of owning the ETFs and not the stock outright. ETFs track the broader market and so the overall yield can work out to be lower than high yielding stock.

Another disadvantage occurs when a stock or fund is affected by the bid and ask spread which can be large and as a result leads to a higher spread, when this happens investors would be better off investing in the actual stocks themselves in some cases. Investors in for the long term may not benefit from daily trading prices which change frequently and cause swings in the prices which may affect the end of day pricing for the fund .

Investors who are interested in ETFs must consult their investment advisors who will walk them through the difference between other investments like mutual funds and unit trust investments and give them a balanced perspective on their investment options to find the right portfolio for their investment objectives.

Lisa Minto is manager, financial planning with Sterling Asset Management Ltd. Sterling provides medium to long term financial advice and instruments in US and other world market currencies to the corporate, individual and institutional investor.

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