Exchange traded funds (ETFs)
Exchange traded funds (ETFs) can be a low-cost way to get
investment returns similar to a share index or another underlying
asset. However, some ETFs are more complex and risky than
Here we explain the risks and what you need to know before you
What is an ETF?
ETFs are a type of investment that can be bought and sold like
shares, through your stockbroker or online trading account.
In Australia, all ETFs are 'passive' investments that track
assets or a market index (for example, an index that tracks the top
200 Australian shares) up or down. ETFs generally do not try to
outperform those markets or assets. ETFs are often promoted
as an easy way to diversify your investments, usually with lower
fees than traditional managed funds.
ETFs are also available for assets such as international shares,
fixed income products, foreign currencies, precious metals and
Types of ETFs
There are two types of ETFs: physical ETFs and synthetic
Most ETFs buy the underlying investments (such as shares and
other assets) on the reference index that the ETF is seeking to
track. These are known as standard or 'physical ETFs'.
If you invest in an ETF, you won't directly own the underlying
investments that the ETF buys (the ETF will own these); instead you
will usually own units or shares in the ETF. Your main investment
risk is the performance of the ETF's underlying shares and other
assets. But there are also other risks, which are discussed
Synthetic ETFs have a material exposure to derivatives as well as the underlying
assets that the ETF is seeking to track. As well as the benefits
and risks of physical ETFs such as 'price errors' and 'fees and
costs', which are discussed below, synthetic ETFs have other risks
to consider. Find out more about the risks of synthetic
When the product is not an ETF
Some products that also track an index or other investments may
'look and feel' like ETFs, but they are not ETFs. These are
structured products, but issuers sometimes use product labels such
as 'exchange traded commodities', 'exchange traded notes',
'exchange traded certificates', and 'exchange traded
There are also exchange traded managed funds and exchange traded
hedge funds that, unlike ETFs, do not simply track an index. For
example, they may try to outperform an index or seek enhanced
returns. The risks of these products can be different and sometimes
much higher than the risks of ETFs.
See other exchange traded
products for more information.
What you need to know before you
The value of a physical ETF investment can rise and fall daily,
usually in line with the index that the ETF is attempting to
Here are some of the features you'll need to know before you
ETF prices will not exactly follow the price of the index or
investments they are designed to track. This 'tracking error' may
be caused by fees, taxes, and other factors.
Under the ASX Quoted Assets (AQUA) market operating
rules, some ETF issuers need to engage 'market makers', who aim to
ensure that the ETF's price stays relatively close to its 'net
asset value' or NAV. This also helps create a more liquid market
Price errors (gapping)
The market price of an ETF unit should be close to the NAV per
unit of the assets held by the ETF. If the offer price you are
quoted by a broker is significantly above the NAV, there is a risk
you might pay far more for an ETF than it's worth. If the bid price
is significantly below NAV, there is a risk you could sell for less
than the underlying investments held by the ETF are worth.
Check the price
You can check if the ETF is fairly priced before you trade by
comparing the offer price (if you're buying) or the bid price (if
you're selling) quoted by a broker with the latest NAV information
available for the ETF.
Many ETF issuers provide NAV updates in 'real-time'. These real
time price updates are referred to as the indicative or intraday
NAV or the 'iNAV'. You can access the latest iNAV from your broker
by prefixing the ETF ticker code with a 'Y' (for example, 'YABC'
for ticker code 'ABC'). Some ETF issuers' websites regularly update
their estimated NAVs.
Fees and costs
While ETFs may have lower fees compared with other management
investments, management fees can vary. Here are some of the costs
- Some management fees may be higher than the fees for an
equivalent (unlisted or unquoted) index fund
- You will also pay fees to your broker or online trading account
(usually at least $20-$30 per trade) to buy or sell ETF units. If
you want to make a small regular investment in a product that
tracks an index, you might be better off using an unlisted managed
investment such as an index fund as
stockbroker fees won't apply to each contribution, although other
fees may apply.
The ETFs' 'buy-sell spread' (the prices that you can buy and
sell ETF units at) can also be a cost for you when you buy or sell
ETF units, though market makers should ensure that the spread
remains relatively small.
If you're selling you can work out the 'buy-sell spread' by
subtracting the bid price from the NAV for the 'dollar spread' and
then dividing the 'dollar spread' by the 'bid price' for the
If you're buying you can calculate the 'dollar spread' by
subtracting the NAV from the offer price, and then calculate
'percentage spread' by dividing the 'dollar spread' by the offer
Exposure to less liquid investments
Some ETFs offer exposure to investments such as small companies,
emerging markets or commodities that may be harder for the ETF to
sell in certain circumstances, or more complex and volatile than
ordinary company shares. This may mean extra risks for
Timing of trades for ETFs that track the share market
To receive an ETF price that is closer to the value of the
underlying assets held by the ETF, only place orders to buy or sell
ETF units at least 30 minutes after the share market opens at 10.00
am EST. This may help you receive an ETF price that is closer to
the value of the ETF's assets.
You should only buy or sell ETFs when the market for the ETF's
underlying asset is open. For example, if you're buying or selling
an ETF that tracks Asian shares, try to place your orders when the
Asian market is open. This may help reduce the price discrepancies
between the ETF and the price of the shares that it holds.
When you buy units in an ETF located in another country (but
also traded on an Australian market such as the ASX) foreign taxes
may apply. For example, if you buy units in a US ETF, US estate
taxes may be payable when you die.
Read the PDS to understand how your investment
will be taxed, and if you're not sure contact the ETF provider or a
If the ETF tracks overseas assets, changes in the value of the
Australian dollar may also affect the value of your investment.
Some ETFs may be 'currency hedged' to reduce this risk.
Specific risks with fixed income ETFs
Fixed income ETFs aim to replicate the performance of assets
such as bonds and debentures.
The Australian Securities Exchange (ASX) has restrictions on
what indices or non-exchange traded bonds or debentures can
underlie an ETF, but these products may still have risks, such
- The value of the underlying assets (bonds) of fixed income ETFs
may rise and fall, therefore the price of the ETF will also rise
and fall to reflect the change in value of its underlying
- The secondary market for corporate bonds (such as the ASX) may
be less active than the market for ordinary shares, making it
harder for the ETF issuer to sell its bond investments.
See ASIC's investing in corporate bonds? for more information
about fixed income investments.
Things to check
Read the PDS carefully, ask questions of the
ETF provider and consider getting professional advice from a
licensed financial adviser. You should also
check recent ASX announcements about the relevant product.
Here are some things to check in the PDS and with the ETF
- Are the ETF's investments liquid (easily bought and sold, such
as blue-chip shares), or are they less liquid investments? It may
be easier to sell your ETF units for a fair price if the ETF
invests in liquid assets and is regularly traded.
- Does the ETF use derivatives? If the answer is yes, the
risks may be higher.
- What are the fees (including hidden fees when you buy and sell
ETF units)? Higher fees may reduce your returns.
- How will the ETF returns be taxed?
- Does the price you're about to buy or sell the ETF at match the
NAV quoted by the ETF issuer? See our tips on how to check the NAV.
- Are you buying an ETF or a different type of exchange traded product
that looks like an ETF? Some of these products may have much higher
risks than ETFs.
- Is the ETF available through the ASX? If you buy an ETF traded
on a market in another country, the same rules and protections may
- Consider the index being tracked. Is it provided by a
reputable index provider? If you're not sure consider getting
advice from your financial adviser or stockbroker.
Before you invest in ETFs do your homework.
Check the details in the PDS and consider getting advice from a
licensed financial adviser. Also remember that diversifying your
investments between different asset classes and product issuers can
help control your risks.
Last updated: 28 Jul 2016