ETFs 101: What advisers need to know

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While some advisers are embracing the lost-cost solution of ETFs, there are still some basic questions being asked.

A couple of ETF experts give a run-down on everything advisers need to know.

How do they work?

State Street Global Advisors head of SPDR ETFs Australia, Amanda Skelly describes an ETF as “a managed fund that is listed on the stock exchange”. She says that for those who know managed funds, that explanation will be very easy.

“You can trade on the stock exchange just like BHP or Telstra...It’s really just a fund that holds a portion of all underlying companies.”

ASIC regulate ETFs, just like they do managed funds, and have developed the industry to make sure all the investor protections are in place, says Skelly.

How can advisers use them?

ETFs can be "boiled down" into three main areas of usage:

  1. Most advisers use ETFs to get simple, easy diversification into a client’s portfolio. With ETFs, with one trade on the stock market you can get portfolio of 200 stocks.

“It’s a really simple way to get more diversified stocks into your company,” says Skelly.

  1. Another common usage of ETFs is using them to reduce the cost in a client’s portfolio.

“This has become more and more important after the FoFA changes that took place in July,” says Skelly. ETFs in Australia are passively managed and they all track an index. They’re generally a lot cheaper than the actively managed funds because you’re not paying for the active management.

  1. Advisers also use ETFs as way to access interesting market exposures. The most popular trend at the moment is overseas companies, says Skelly. There’s more than 90 ETFs available on the ASX and approximately 20 are in international markets, she says.

ETFs can be used in combination with managed funds or in combination with direct stocks.

What are the risks involved?

Skelly says the biggest risk is advisers understanding the ETF that they’re buying and the type of market exposure that they’re getting.

“So knowing what the index is and how that ETF seeks to track that index.” Some ETFs will buy every stock in the index, some ETFs will buy most of them, and some – not many in Australia – will use derivatives to track that index.

Jonathan Howie, Director and iShares Specialist at BlackRock, says that one of the key areas for advisers to consider when selecting ETFs or managed funds is the quality of the issuer.

“Investors must satisfy themselves that the issuer has the size and commitment to stand behind the products. They must also satisfy themselves that the issuer can support the products with best-practise risk management platforms. The timeliness and quality of information available from the issuer is also crucial in determining the most appropriate product provider.”

Are they suited to a particular investor?

“They are suitable for all clients, but how clients use them will be very different,” says Skelly.

For clients who want to outsource everything to the adviser, she says an ETF works best as a core, low-cost holding to get simple diversification. For the more active client that likes to play in the stock market, they will generally use more of a niche strategy – like technology or Asia – and will trade more frequently.

They are available on and off platform, what are the pros and cons each way?

Platform use of ETFs has grown rapidly over the past 12-18 months, and Skelly says that some ETFs have experienced a 20% increase in adviser usage on platforms. She says that most advisers have their business built around a platform so it makes the administration a lot easier.

However, there are additional costs for advisers using on platform, including the administration fee that has been coming down. Off platform, advisers have to do the administration themselves, so Skelly says it depends on the type of business an adviser manages.

Are there any final tips for planners?

It is vital that advisers understand the total cost of investing, including the management fee, the broker commissions and the spread on the ETF, says Skelly. “If they’re not comfortable with the liquidity or the price they’re seeing, they should call the ETF issuer.”

“One piece of advice…Make a first trade, get comfortable with it, see how it works in your business and then once you’re comfortable, then we’ve seen more advisers widely adopt it. Often the first step is the hardest, the first trade is the hardest.”