ETFs

Exchange-traded funds are one of fastest growing fund structures created for investors in recent years.

In brief, an ETF is a basket of securities, a fund, that you can buy or sell through a trading platform on a stock exchange. ETFs are offered on a wide range of asset classes from traditional investments to so called alternative assets. In addition, they sometimes allow investors to short markets, to gain leverage, and provide easy access to active management. Active ETF strategies, QuotedData’s raison d’etre, is the fastest growing space, with fund managers managing the fund, and you’ll see more of these funds popping up, with greater coverage from us over time. Active ETFs do need different analysis, so we’ll provide regular coverage, by keeping in touch with the manager and reporting back, via our team providing videos, news, research and data analysis at QuotedData.com.

Ultimate Guide to Exchange-Traded Funds (ETFs)

What is an Exchange-Traded Fund (ETF)?

An Exchange-Traded Fund (ETF) is a versatile investment vehicle that offers exposure to a collection of assets—such as stocks, bonds, or commodities—without requiring individual purchases of each asset. ETFs typically track an index, like the London Stock Exchange (LSE’s) 100 largest companies, an asset class (such as government bonds), a market segment (such as bonds maturing within five years), a region, or a specific sector. These ETFs are known as “passive” funds, designed to mirror the performance of a chosen index rather than surpass it. This is in contrast to “active” funds, which aim to outperform benchmarks by actively buying and selling assets.

Additionally, ETFs are structured as “open-ended” investments, meaning they create new units when investors buy in and redeem them when investors sell. Like all exchange-traded products, ETFs can be bought and sold on major stock exchanges, such as the London Stock Exchange, making them highly accessible for everyday investors.

Why Invest in ETFs?

ETFs offer several key advantages, making them a popular choice for both beginner and seasoned investors:

  1. Cost Efficiency: ETFs generally have lower fees compared to actively managed funds. For example, an ETF tracking the FTSE 100 can have fees as low as 0.07%, versus 1.01% for typical UK mutual funds (see our data tables for updated numbers).
  2. Flexibility: Unlike unit trusts, which trade once daily, ETFs can be traded any time the exchange is open. This intraday trading capability offers significant flexibility in portfolio management.
  3. Transparency: ETFs provide daily transparency of their holdings, making it easy to understand the assets within the fund.
  4. Diversification: ETFs allow investors to diversify their portfolios with a single trade. For instance, purchasing an ETF that tracks an index’s largest companies provides fractional exposure to these companies at a fraction of the cost and complexity of individual investments.

Selection Process – Some Aspects to Take into Consideration when picking an ETF

In selecting ETFs, do refer to our data pages at QuotedData.com and research, factoring in these points:

  1. Cost Analysis: While fees are a factor, factor in the Total Expense Ratio (TER) as well as trading costs and fund performance.
  2. Liquidity and Size: Larger, highly traded ETFs generally offer tighter bid-ask spreads, reducing the cost of trading. Smaller funds or those with low trading volume may have wider spreads, which can detract from performance. So check out their size, liquidity and spreads.
  3. ETF Type: ETFs come in two primary forms—’physical’ and ‘synthetic’ (or ‘swap-based’).
    1. Physical ETFs: These replicate the index by holding the actual securities within it, often either fully replicating (buying every index component) or using a stratified sampling approach.
    2. Synthetic ETFs: These use swap agreements to replicate index performance without holding physical securities. Synthetic ETFs can reduce certain costs and tax impacts, such as withholding tax on dividends.
  4. Currency Choices and Considerations: ETFs are available in various currencies, with Sterling, US Dollars, and Euros being common options. For UK investors, US indices are often available in both Sterling and Dollars. However, currency fluctuations can impact returns, and you may wish to consider currency-hedged options where appropriate to reduce this risk.
  5. For Passive funds – Index Components: Evaluate each index to determine its composition and relevance. Key considerations include sector concentration, geographic exposure, and market capitalisation. Select indices that align with your investment goals and philosophies. Much has been spoken about with the US indexes, with their high exposure to the magnificent 7, adding greater risk and volatility than you may imagine.
  6. For Passive or smart beta funds – Tracking Methodology: Consider an ETF’s tracking method, focusing on minimising tracking error—the gap between the ETF’s performance and that of the underlying index. Some funds use optimisation, holding a subset of index components to replicate performance. Aim to choose ETFs that closely mirror the index’s performance.
  7. For Active ETFs, research the manager, process and strategy, via QuotedData.com

Understanding Different Types of ETFs: Passive, Active, Smart Beta, and More

Exchange-Traded Funds (ETFs) offer diverse ways to invest in stocks, bonds, sectors, and themes. With various types, investors can find ETFs tailored to specific goals, whether for low-cost, passive investing or more active, strategy-driven opportunities. This guide breaks down the main ETF types, including Passive ETFs, Active ETFs, Smart Beta ETFs, and other specialised options like Thematic ETFs and Bond ETFs.


1. Passive ETFs: Low-Cost, Broad Market Exposure

What Are Passive ETFs? Passive ETFs are designed to replicate the performance of a market index. Rather than trying to outperform the market, these funds aim to match the returns of an index, like the S&P 500 or MSCI World Index. They use a “buy-and-hold” approach, where holdings are rarely changed, minimising fees and costs.

Why Choose Passive ETFs?

  • Cost-Effective: Passive ETFs usually have low fees because they require minimal management.
  • Transparency: They provide daily insights into their holdings, making it easy for investors to see what they own.
  • Broad Diversification: By tracking a large market index, passive ETFs offer exposure to a wide array of stocks or bonds, spreading out investment risk.

Ideal for: Long-term investors who want low-cost exposure to a broad market without needing to outperform the index.


2. Active ETFs: Seeking to Outperform the Market

What Are Active ETFs? Unlike passive ETFs, Active ETFs are managed by investment professionals who aim to beat the market, not just match it. These funds involve buying and selling stocks based on research, trends, and market conditions. Active ETF managers make strategic changes to holdings, aiming to generate higher returns.

Why Choose Active ETFs?

  • Potential for Higher Returns: Active management may lead to outperformance compared to standard indexes.
  • Advanced Strategies: These ETFs can tap into strategies usually reserved for institutional investors, like emerging markets or sector-specific investments.

Ideal for: Investors with higher risk tolerance who are comfortable with active management fees in exchange for the potential of market-beating returns.


3. Smart Beta ETFs: A Strategic Blend of Active and Passive Investing

What Are Smart Beta ETFs? Smart Beta ETFs follow a unique rules-based approach, blending the benefits of passive and active investing. They still track an index but focus on specific factors, like earnings, value, or dividend yields, rather than just market capitalisation. This approach lets investors access strategic factor investing without active management costs.

Why Choose Smart Beta ETFs?

  • Enhanced Returns: Smart Beta ETFs aim for improved performance by targeting financial metrics beyond simple size.
  • Risk Management: Factor-based approaches can help control risk by focusing on attributes like stability or growth potential.

Ideal for: Investors looking for a middle-ground between active and passive investing, with risk-adjusted returns from factor-based strategies.


4. Thematic ETFs: Targeting High-Growth Sectors and Trends

What Are Thematic ETFs? Thematic ETFs focus on specific investment themes, such as clean energy, technology, or artificial intelligence. Rather than tracking a single sector, they include companies from various sectors aligned with a broader theme. This allows investors to tap into global megatrends with targeted exposure.

Why Choose Thematic ETFs?

  • Focused Exposure: Thematic ETFs provide exposure to high-growth industries, often aligning with emerging trends.
  • Long-Term Growth Potential: These ETFs tend to follow themes with significant long-term growth prospects, like renewable energy or healthcare innovation.

Ideal for: Investors with a high tolerance for risk who want concentrated exposure to specific industries or global trends.


5. Sector and Industry ETFs: Focusing on Specific Economic Sectors

What Are Sector ETFs? Sector ETFs track individual sectors like technology, healthcare, or utilities. They enable investors to concentrate on one part of the economy, which can be beneficial for those looking to leverage specific sector trends or cycles.

Why Choose Sector ETFs?

  • Targeted Investments: Ideal for those seeking exposure to specific industries.
  • Flexible Exposure: Investors can choose sectors based on their own economic outlook or defensive growth objectives.

Ideal for: Investors looking to benefit from sector-specific performance and tailor portfolios to their economic views.


6. Bond and Fixed-Income ETFs: Stable Income with Lower Volatility

What Are Bond ETFs? Bond ETFs invest in debt securities, providing exposure to fixed-income markets. They typically focus on certain types of bonds, like government and corporate bonds that come with regular interest income.

Why Choose Bond ETFs?

  • Income Generation: Bond ETFs offer regular income, attractive to income-focused investors.
  • Lower Risk: Compared to stock ETFs, bond ETFs generally have lower volatility, making them a popular choice for conservative portfolios.

Ideal for: Investors looking for income and lower volatility within their portfolios, or for balancing risk.


Summary of ETF Types

ETF TypeDescriptionRisk ProfileBest For
Passive ETFsTrack an index for low-cost market exposureLow to ModerateLong-term investors focused on cost and simplicity
Active ETFsAim to outperform the market with active managementModerate to HighThose seeking potential high returns
Smart Beta ETFsRules-based ETFs with specific factors like valueModerateBalanced investors seeking strategic exposure
Thematic ETFsTarget global megatrends and high-growth sectorsHighTrend-driven investors
Sector ETFsFocus on specific economic sectorsVaries by sectorInvestors focusing on sector performance
Bond ETFsProvide exposure to fixed-income securitiesLow to ModerateIncome-focused or conservative investors

ETFs vs. Mutual Funds/OEICs/UCITs

Though similar in that both pool investor funds to create a diversified investment vehicle, ETFs differ significantly from mutual funds:

  1. Trading Flexibility: ETFs trade continuously on exchanges, whereas mutual funds typically trade once daily.
  2. Price Transparency: ETFs provide real-time pricing, while mutual fund prices are set at the end of each trading day.
  3. Broader Access: ETFs offer greater diversity in asset classes, geographic exposure, and investment styles compared to mutual funds, providing enhanced flexibility for portfolio management.

 

Risks of ETFs

While ETFs offer significant benefits, they also come with inherent risks:

  1. Market Risk: ETFs reflect the performance of their underlying assets, so if the market or asset class they track declines, the ETF will lose value. This is especially pertinent in equity or commodity ETFs, which can be highly volatile.
  2. Liquidity Risk: While most ETFs are very liquid, some may have low trading volumes, especially in niche or emerging markets, making them harder to buy or sell at the desired price. Illiquid ETFs may have wider bid-ask spreads, increasing transaction costs.
  3. Tracking Error: ETFs aim to replicate the performance of an index, but fees, trading costs, and rebalancing can lead to slight deviations from the benchmark index. This is especially common in leveraged or inverse ETFs, which reset daily and can experience compounding effects over time.
  4. Counterparty Risk: Some ETFs, especially synthetic ones, use derivatives to replicate index performance, exposing investors to counterparty risk. If the counterparty fails, there could be a financial impact on the ETF’s value.
  5. Currency Risk: If an ETF holds foreign assets, currency fluctuations between the local and the investor’s home currency can impact returns. Currency-hedged ETFs are available, though they may be costlier.
  6. Management Risk: ETFs are not immune to human error or judgment calls, particularly in actively managed ETFs where fund managers make decisions about which assets to hold.
  7. Tax Implications: ETFs can have different tax implications depending on the type, domicile, and underlying asset class. For instance, bond ETFs may incur taxes on interest payments, and foreign ETFs may also involve withholding taxes.

Understanding these risks is essential for investors to make informed decisions when selecting ETFs that align with their financial goals and risk tolerance.


This guide provides a comprehensive introduction to ETFs, from selection criteria to risk considerations, allowing you to make be better informed to make choices to suit your investment objectives. Whether your goal is diversification, cost savings, or access to unique sectors, strategies and even managers, ETFs can serve as a powerful tool in building a resilient, diversified portfolio.