There is a new method of investing in the stock market, reducing the Risk associated with direct company investment, and providing easy access to global markets, sectors and commodities. It is Exchange Traded Funds, or ETFs. But they have been around for more than 20 years!
An Exchange Traded Fund is an investment fund traded on the stock exchange. It will hold assets such as stocks, commodities, bonds, or futures contracts, with most tracking an index, or select group of stocks or commodities. They are traded just like a stock on the exchange, but instead of it being a company that raises capital for expansion of investment, it is a Fund that invests in the equivalent stocks, commodities or futures that it’s preceding index represents.
What is an ETF
The best way to describe an ETF is to provide an example. The DOW Jones Industrial Average is an index that represents the top 30 companies listed on the US markets. The public uses this index as an indicator to how the top 30 companies are performing on any given day. It is a benchmark of market performance.
Whilst the index represents the top 30 companies, it does not own shares in them or have any direct investment whatsoever. Although there may be futures or options contracts over the DOW Jones index, the index itself is merely a representation of the movement of those 30 companies.
There is an Exchange Traded Fund (ETF) that represents this index. Having raised funds to list on the stock exchange, DIA (SPDR Dow Jones Industrial Average ETF) provides investment results that generally correspond to the price and yield performance of the DOW Jones Industrial Average. To do t his, the fund purchases shares in the top 30 companies, ensuring they have similar weightings in the percentage of shares per company.
Therefore, the ETF (DIA) will replicate the performance of the DOW Jones index.
ETF’s are quite diverse. There are literally thousands of them listed on the American exchanges, and their popularity is steadily increasing. Some also pass on the dividends they receive from the companies they are invested in, or provide access to exotic markets such as China, Brazil or Thailand. All the while, your capital is invested on the local market.
Here in Australian we have a fledgling ETF market. Volume activity is by no means excessive and suitable for short-term traders, but the liquidity is still sufficient for investors to gain exposure for medium to long-term positioning.
The Australian Stock Exchange (ASX) provides ETFs for Australian indices and products, International, Commodity, Fixed Income (Bond), Currency and Cash. As investors continue looking for improving yields and managed Risk, these products are going to increase in volume activity. We will eventually see them become optionable, and that will open the flood gates for various strategies.
ETF Forecast 2014
Our view is that investors will continue to flock to ETFs, both in the US and here in Australia. When we consider the growth rate of US ETF’s, as depicted in the graph below, we can clearly see an emerging industry. Australia is literally at the start of a similar growth phase.
By the end of 2012, net asset value of US ETFs was $1.3 trillion, up 27.5% from the year before. In the last 10-years, the value of US ETFs has grown more than 1200%. With the global economy slowly moving forward, 2014 will be a year where investors search for stability of returns. And ETFs will be one space where there is a huge amount of activity.