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A cheaper form of investment.


ONE of the major trends in fund management over the last few years has been the drive to lower costs for investors.

This has been further boosted by the retail distribution review which has laid bare fund charges to many investors for the first time.

One of the main sectors to benefit from this change has been Exchange Traded Funds (ETFs). It's been nearly 15 years since these funds took the plunge on European stock exchanges and their star shows no sign of waning.

Indeed, by the end of 2013 there was $412 billion invested in ETFs in Europe. There was a further boost in the Chancellor's autumn statement when he removed stamp duty from purchases of UK-based ETFs.

The industry has snowballed since the debut of the iShares DJ Stoxx 50 and iShares DJ Europ STOXX 50 on the Deutsche Bourse in April 2000. London investors got in on the act with the launch of the iShares FTSE 100 later that month.

But what is an ETF and why should investors be interested in them? Exchange traded funds are an easy and cost-effective way for investors to achieve the same returns as they would from investing in an index such as the FTSE All Share or India's "Nifty Fifty" index. Unlike tracker unit trusts, which track indices, ETFs are shares that can be bought and sold on the stock market like any other shares.

They benefit from intra-day trading at, or close to, net asset value and can give access to a whole market by the purchase of just one share. They can be bought and sold easily through a stockbroker or financial adviser.

Like traditional index funds, ETFs work best as a long-term investment play. They offer a convenient and cost-efficient alternative to purchasing all of the underlying securities of a particular index. They are effectively an entire market wrapped up in one share as they invest in a basket of securities from a particular index so by purchasing a FTSE All Share ETF, you are getting access to the performance of the entire FTSE index, while a commodities ETF will provide access to the entire asset class. ETFs are generally cheaper than traditional funds. A typical total expense ratio of an ETF is between 0.3 and 0.4 per cent compared with about 1.6 per cent for actively managed funds while indextracker OEICs have charges of up to one per cent. They are cheaper than active funds as they do not need to be actively managed, so investors need not employ the expertise of analysts.

Still the expense advantage of theese funds over index-trackers may prove to be more mirage than fact for some investors. That's because you must pay commissions to buy and sell ETFs, just as you would for stock transactions. If you plan on making a single, lump-sum investment, then it will almost certainly pay to choose a cheaper ETF.

However, for those who plan to make regular, relatively frequent investments, if you have access to a fund that does not carry sales charges that will often be cheaper than buying the ETF and paying commissions.

ETFs have a lot to offer. They're flexible and low-cost, and their underlying portfolios are protected from the impact of investor trading, making them more efficient to manage than traditional OEICs and unit trusts.

However, they are not a complete panacea for all investment portfolios. Remember, however low cost an ETF is, it still simply tracks an index. If the FTSE 100 goes down by 40 per cent the value of an investment in a FTSE 100 ETF will go down 40 per cent. While evidence suggest most active fund managers can't outperform the markets over the long term, several actually have.

As with any investment, it is important to diversify across a range of geographical area and asset classes, and to treat them as a long-term holding. ETFs in themselves don't guarantee returns, they just make investment cheaper and somewhat simpler.

Look carefully before you leap.

ETFs' cost advantage isn't always as large as it might seem, and trading costs can quickly add up. Particularly if you wish to invest regular sums of money, you may be better off choosing a traditional fund without sales charges.

If you're investing a lump sum, however, or if you can't access a fund without paying an initial or deferred charge, ETFs may well give you the best value for money.

Trevor Law is a director with Merito Financial Services, chartered financial planners, in Solihull.

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Title Annotation:Business
Publication:The Birmingham Post (England)
Date:Feb 6, 2014
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