04: Exchange traded funds

Exchange traded funds (ETFs) are listed open-ended investment companies which are usually designed to track a particular index. They are thus a hybrid between an OEIC and an investment company. The number of shares in issue can rise or fall according to demand, unlike an investment company. The ETF structure means that the fund’s share price will normally very closely follow that of the underlying index. ETF shares are traded throughout the day with real-time dealing, whereas an index-tracking unit trust or OEIC is generally dealt in and priced only once a day.

• ETFs normally have very low management charges – typically less than 0.5%.
• They are dealt with on the stock exchange, but are not subject to stamp duty.
• ETFs now cover an extensive range of investment sectors, including some highly specialist areas such as infrastructure and private equity.
• Many ETFs use derivatives rather than investing directly in an index’s underlying securities. This can have tax advantages, but introduces an element of counterparty risk.
• Some ETFs, strictly called exchange traded commodities (ETCs), offer exposure to commodities. Most commodity-based funds gain their exposure via derivatives, but a few ETCs hold the physical asset (eg gold bullion).

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