An Exchange Traded Fund (ETF) is an investment fund, similar to a managed fund, that is traded on a stock exchange like any other share. ETFs are one of the fastest growing categories of investment products in the world. They offer simple, liquid, transparent, low-cost and flexible investment options. The aim of most ETFs is to closely track the performance of a given index or asset class, and provide the returns of that index or asset class, less any fees. ETFs provide access to a range of bonds, shares (both domestic and global), or other asset types (such as commodities or listed property).

ETFs trade exactly like an ordinary share, so if you are able to buy and sell shares then you are able to buy and sell ETFs through a broker. There is no need to open a separate trading account. ETFs charge a simple, cost-effective management fee and no performance fees.

ETFs offer investors flexibility to implement a wide range of investment strategies. For example, ETFs can be used as core holdings in a portfolio and as building blocks for portfolio construction of broadly diversified indices or asset classes. Or investors can use a broad Australian shares ETF to ‘buy the market’ and instantly gain exposure to the Australian market in a single trade.

For the past few years, Self-Managed Super Funds (SMSFs) have embraced the use of ETFs.

The recent BetaShares/Investment Trends ETF Report found that the number of SMSFs holding ETFs has grown from 76,000 in 2014 to 83,000 in 2015. There is now about $25 billion invested in ETFs listed on the Australian Securities Exchange (ASX).

The connection in the growth of SMSFs and ETFs is not a coincidence, as the forces driving the surge in popularity in each are essentially the same, that is, investors’ desire to:

  • Take control of their investments
  • Reduce the costs of investing
  • Improve transparency and simplicity
  • Improve the tax outcome of investments

Adopting a long-term investment approach
ETFs give exposure to asset classes without the need to pick stocks individually. Many SMSFs are adopting a top-down approach, putting greater emphasis on the analysis of sectors or industries, instead of company by company analysis. ETFs also enable SMSFs to adopt a long-term, ‘buy and hold’ approach to investing, because SMSFs are aligned specifically to the needs of their trustees and members. The investments can be used to build a tailor-made portfolio around specific retirement needs.

Buying shares and holding them until they ultimately are sold down in retirement (or hopefully not at all) is difficult to achieve using traditional managed funds. This is because active managers buy and sell shares frequently to try to outperform their benchmarks. Thus, actively managed funds will often have high levels of turnover, which acts as a performance drag.

In contrast, ETFs typically have significantly lower levels of turnover. This lower turnover reduces the number of tax events over a given time period and can also help by allowing franking credits on share dividends to accumulate over time.

ETFs can also reduce the costs of investing. One of the few elements of an investment strategy that an SMSF trustee is able to control is management fees. This is particularly relevant given the reality of performance recorded by the majority of active managers who struggle to outperform their respective benchmarks over various time periods.

Finally, there has been a recognition by SMSF investors of a need to diversify away from Australian equities and property in their investment portfolios. As ETFs can be bought and sold like any share on the ASX, many SMSFs are turning to ETFs to obtain their global equity exposure. Indeed, the launch of numerous ETFs that provide exposure to international markets with a currency hedge component is likely to continue to drive this trend.

Ideal for superannuation
A major trend from a product development perspective has been the emergence of objectives-based products that have been specifically designed for pre-retirees, superannuation and SMSF investors. Examples of these include ‘managed-risk’ strategies and ‘dividend-oriented’ investments.

Managed-risk funds, for example, aim to provide exposure to Australian or global sharemarkets while seeking to reduce the volatility of the equity investment returns and defend against losses in declining markets. Products such as these are designed to cushion downside risk and have obvious appeal for superannuation.

Dividend-oriented funds, on the other hand, are also an option for SMSFs to structure their portfolios around income generation. Some funds aim to maximise franked dividends with regular income distributions.

The flourishing of new products in the past couple of years has made it easier for SMSFs to tailor their investments according to their specific investor needs.

What would you like to read about next? Let us know in the comments below.

Read more: