This week, over 900 investment professionals gathered in Hollywood Florida for the largest Exchange Traded Fund (ETF) conference on record. During their coverage of the event, CNBC shone a particularly interesting light on the ETF industry. According to the report, the total asset size of the ETF industry recently surpassed the US$1 trillion mark (approximately three times the size of the US mutual fund market). According to Tony Rochte of State Street Global Advisors this reflects a phenomenal growth of funds from specific sources: particularly financial advisors as well as large institutional investors such as hedge funds and pension plans. What is it about this investment product that is attracting so many sophisticated investors? Let’s find out.

What are ETFs?

An exchange traded fund is, as the name suggests, a fund that trades on an exchange. Similar in principle to a mutual fund, the Exchange traded fund pools funds from investors and invests in one or more financial instruments (e.g. one of or a combination of stocks, bonds, currencies or commodities). However, the differentiating factor for an ETF is the way in which it trades. An ETF is listed on a stock exchange and trades like a stock i.e. throughout the day and instantaneously.

Types of ETFs

There is a wide array of ETF’s and they can be classified according to an equally wide array of characteristics. An ETF may be grouped according to the asset class in which it invests i.e. commodities, currencies, fixed income or equity, real estate. An ETF can also be classified according to the industry in which it invests e.g. Energy, Financial, Technology, Utilities or even the jurisdiction in which the investment is domiciled e.g. the Hong Kong, India, The U.S., Europe etc. There is almost undoubtedly an ETF out there to suit your appetite and interests.

Benefits

ETFs allow investors to participate in markets they otherwise may not have been able to

Many markets, particularly those for commodities, derivatives, real estate and some fixed income instruments are not easily accessible by some investors for a variety of reasons, such as regulatory restrictions and high minimum requirements. Sometimes investors even make a conscious decision to stay out of a particular market due to their lack of knowledge or experience in the particular market. However, an ETF allows investors to take advantage of investment opportunities and expertise that it normally would not have been able to access independently. For example, owning a Gold ETF, alleviates the security and storage costs associated with the outright ownership of physical gold bars.

ETFs are also a good way to take advantage of opportunities in emerging markets. The ETF allows an investor to be guided by a Fund Manager in the selection of potentially lucrative investment positions in a particular industry or asset class. This reduces the time you spend selecting, analyzing and researching individual investment opportunities.

Lower expense ratios

ETFs are reputed to have lower fees and expenses relative to their mutual fund counterparts, making it an economical investment, especially in the long term.

Risks

Limited data: ETFs are a phenomenon of the last two decades – the majority of ETF issuance took place during 2000 to 2011. As such, their performance history is limited. Investors must familiarize themselves with the assets in which the ETF invests and the general investment strategy of the fund, to ensure that it corresponds with their risk appetite and investment objectives.

Quality of fund manager: like all investment products designed and managed by a financial institution, the success of the fund is ultimately dependent on the ability of the fund manager to generate sustainable results. Be sure to familiarize yourself with the bios of your fund managers and ensure that you understand the fees and hurdle rates that may be associated with the ETF.

Contact your financial advisor to help you select an ETF that is right for you.

Marian Ross is a business development officer with Sterling Asset Management Ltd. Sterling provides medium to long term financial advice and instruments in U.S. and other world market currencies to the corporate, individual and institutional investor.

Feedback: If you wish to have Sterling address your investment questions in upcoming articles, send us an email at info@sterlingasset.net.jm or visit our website at www.sterling.com.jm