ETF investing has risen dramatically in popularity over the last decade – attracting attention from a new generation of hands on investors.
Those trends have continued upwards despite recent market volatility: inflows into ETFs topped US$89 billion in 2022, with the majority of inflows going towards equity ETFs, at US$59.3 billion, followed by fixed income ETFs which brought in US$39.2 billion.
In this guide we’ll break down the most important aspects of ETF investing for Australian investors – from the key terms, strategic considerations, and performance metrics – to help you elevate your knowledge of ETFs.
Keep on reading to discover more about ETF investing in Australia, or jump ahead to the section that interests you the most:
What is an ETF or Exchange Traded Fund?
ETFs or Exchange Traded Funds are pooled investment funds that tend to track a specific stock market index or benchmark.
Many popular ETFs track broad-based stock market indices like ASX 200 and S&P 500 – giving investors the ability to quickly and easily diversify their portfolios across hundreds of companies, in just one trade.
Unlike mutual funds, ETFs can be bought and sold on a stock exchange like individual shares.
What is ETF investing?
ETF investing is an investment strategy that focuses on allocating capital into ETF products – from passive ETFs which track indexes ASX 200 or active ETFs such as Cathy Wood’s ARK Innovation ETF which invests in some of the world’s most exciting technology companies.
Whatever approach you take – investing in ETFs is generally considered a less risky and more hands off approach to investing than individual stock picking – due to the inherently more diversified nature of an ETF.
ETF investing: key terms to know
Before we dive into investing strategy, here are the key terms you need to know when it comes to ETF investing:
Management fees & expense ratios
Management fees refer to all the costs associated with the running of an ETF. For investors, these management fees are expressed as an expense ratio – which can be located on the product page of an ETF.
The expense ratio is arguably one of the most important metrics to be aware of when it comes to ETF investing – as high fees can drag on long term performance.
In real terms, for an ETF that has an expense ratio of 1.00% – it means that for every A$10,000 invested, your ETF would attract A$100 in fees annually. All fees or costs associated with ETF investing are calculated on a daily basis and are deducted automatically by the ETF provider.
A stock market index or benchmark index, represents a collection of different stocks or businesses. Passive ETFs are constructed to track different indexes and generally closely replicate the performance of an index.
For example, buying an ETF that tracks the ASX 200 – like the iShares S&P 500/ASX200 ETF – will give you exposure to the top 200 public companies in Australia.
A tracking error is the deviation between the performance of an ETF and the underlying index that the ETF tracks. Tracking errors can occur as a result of operation costs, including management fees, trade execution costs and potential foreign exchange rate movements.
Net asset value or NAV
Net asset value refers to the total value of all the assets held by an ETF, minus its liabilities and divided by total shares outstanding.
Most sufficiently large ETFs will likely trade at a price very close to their Net Asset Value (NAV). This means that their price is usually in line with the value of all the investments held in the fund.
An ETF might trade above or below its NAV for a number of reasons, including low demand for the ETF or concerns about one or more of its underlying holdings.
What Type of ETFs can Australians invest in?
There are primarily two types of ETFs that investors can buy on the ASX – passive ETFs and active ETFs.
Passively managed ETFs refer to ETFs which closely track a stock market index, like the ASX 200, the S&P 500, the Nasdaq 100, and more.
Ultimately, the aim of a passive ETF is to track – to have the lowest ‘tracking error’ – of its reference index as possible.
Passive ETFs have become popular for three main reasons.
One, passive ETFs generally have lower costs than mutual funds, while allowing for comparable investment diversification.
Two, benchmarks like the S&P 500 and ASX 200 have historically helped investors achieve strong single-digit returns, over a relatively long period of time.
Three, passive ETFs have made the process of individual investors diversifying their portfolio simple, allowing investors to build portfolios made up of hundreds of high quality stocks, in just one trade.
As passive ETFs have risen in popularity, we’ve also seen the proliferation of active ETFs. This class of fund refers to an ETF where an investment manager or investment team actively manages or selects a portfolio of stocks or other investments.
Rather than tracking a benchmark index, active ETFs tend to be thematic or follow a strategy set out by the ETF investment manager or its team.
For example, Cathy Wood’s ARK Innovation ETF focuses on investing in technology stocks, with Wood standing out as a key figurehead and bull on names like Tesla, Teladoc, and Robinhood, as well as other alternative assets.
As the Wood example suggests, the investments which make up an active ETF tend to follow a consistent theme or investment idea, and can include anything from artificial intelligence and machine learning, energy & natural resources, fixed income, and more.
Unlike a passive ETF which is constructed to ‘closely track’ the performance of a stock market index or benchmark, the management team of an active ETF is generally seeking to outperform an index.
What are the benefits of ETF investing?
ETFs offer investors a quick, easy, and low cost way to diversify their current investment portfolio or start their self-directed investment journey. Here are three benefits of ETF investing to consider:
1. Low costs
Low cost has been the key driver of ETF popularity over the last decade. Passive ETFs tend to charge lower fees than actively managed ETFs and mutual funds, which employ teams of experts and analysts to select and trade investments.
Low management costs have long been considered one of the key selling points of ETFs, with passive ETFs being able to operate with lower fee structures as a result of management and administrative cost efficiencies.
Here are a number of ASX-listed ETFs than have extremely low management fees:
|iShares S&P 500 ETF
|Betashares Australia 200 ETF
|iShares Core MSCI Australia ESG Leaders ETF
|iShares S&P Small-Cap ETF
|iShares Core Cash ETF
*Data correct as of 8 February, 2023.
By comparison, active ETFs tend to charge higher fees. Paying experts to manage the fund, the expectation of superior returns to their passive counterparts, as well as more trading in and out of investments – all adds to the cost associated with running a fund.
Remember, a passive ETF is trying to match, not beat the index that it tracks. An active ETF is trying to outperform it. In saying all this, active ETFs tend to have lower management fees or expense ratios than active mutual funds.
Beyond costs, one of the most significant benefits of ETF investing is that it allows you to instantly diversify your investment portfolio, in a single trade.
By investing in an ETF that tracks the ASX 200, you immediately gain exposure to Australia’s top 200 publicly traded companies. This would give you exposure to not just the well-known ASX stocks like CBA, CSL, and Telstra, but also lesser known companies like Dicker Data, Regis Resources, and Judo Capital.
As an individual investor if you wanted to invest in all 200 companies on the ASX 200 – not only would you require a large amount of capital but it would take significant time and incur significant brokerage costs.
One important call out: diversification shouldn’t be thought of as purely a numbers game. Diversification should also be thought of in terms of different countries, sectors, and asset classes – like bonds and other alternative assets.
And while diversification won’t guarantee that your investment portfolio will go up, it will mean that you are well placed to weather periods of volatility.
Warren Buffett has long been a proponent of ETF investing – due to the strategy’s ability to provide consistent returns over the long term. Buffett’s main point is that while beating the market is possible, it is difficult or at the very least, time consuming, for individual investors.
For those who don’t have the time or inclination to follow the market closely or research individual stocks deeply, ETFs which track large indexes like the Nasdaq 100, the ASX 200, or the MSCI index have historically delivered strong returns to patient investors.
Long term ETF investing performance
Here’s a look at how some of Australia’s most popular ETFs have performed over the short and long term:
|3 Years PA
|5 Years PA
|Since Inception PA
|Betashare Nasdaq 100 ETF
|iShares S&P 500/ASX200 ETF
|Betashares Sustainability Leaders ETF
|iShares Global 100 ETF
|SPDR MSCI AUS Select High Dividend Yield Fund
*Data correct as of 8 February, 2023.
Finally, ETFs offer investors flexibility to try out new strategies and gain exposure to different sectors, exotic asset classes, and investment thematics. This allows investors to invest in the products that are aligned with their investment objectives or personal preferences.
This is useful for investors who want to directly invest in areas like sustainability or artificial intelligence & machine learning without spending significant time researching the many companies in these areas.
Here are a number of Australian ETFs exploring on trend investment themes:
|Future of Payments ETF
|Asia Technology Tigers ETF
|Digital Health and Telemedicine ETF
|Global Cybersecurity ETF
|Global Robotics and Artificial Intelligence ETF
|Artificial intelligence and robotics
*Data correct as of 7 March 2023.
ETF investing: what to look for when investing in an ETF
When it comes to ETFs investing, here are four key factors to consider:
1. Management fees
As we’ve discussed – given that ETFs do incur some costs – it’s important to know the management fees or expense ratios, as even small fees can impact returns over the long term.
For example, while the iShares Core S&P 500 and SPDR S&P 500 ETF Trust both track the S&P 500 index, they have slightly different management fees, of 0.04% and 0.09%, respectively.
While fees aren’t the only factor you should consider when making an investment decision, they shouldn’t be ignored.
2. Underlying index
Primarily related to passive ETFs, understanding the constituents or weightings of the underlying index that an ETF tracks is important.
For example, did you know that 51.5% of the ASX 200 index is made up of financial services and basic materials (resources) companies? The S&P 500 exhibits a similar concentration: 53.1% of the iShares S&P 500 ETF is made up of information technology, healthcare, and financial services companies.
What this means is that when you invest in an ETFs a significant portion of your investment might actually be concentrated in just a few industries. While this is not necessarily a negative characteristic, it should be factored into your thinking when making ETF investments, especially as it relates to how realistically diversified your portfolio is.
3. Tracking error
Some fund managers are better at closely tracking their benchmark indexes than others. As with costs, poor tracking can eat into returns over the long term and should be considered when making an ETF investment.
Since inception, and looking at the average annual performance, the iShares S&P 500 ETF has a relatively small tracking for example:
|Product / Index
|iShares S&P 500 ETF
*Data correct as of 8 February, 2023.
When it comes to ETFs – liquidity, which refers to how quickly or easily an asset can be sold – is an important consideration. For ETFs, a few factors might contribute to or inhibit liquidity.
Overall, daily trade volume is a good indicator of liquidity.
The Betashare Australia 200 ETF, which tracks the popular ASX 200 index for example, has significantly higher daily trade volume than the Betashares Future of Payments ETF, which is comprised of a more unique set of technology and payments companies.
The individual liquidity of the underlying constituents in an ETFs also factors into an ETF’s overall liquidity.
The liquidity of assets in an ETF that tracks the S&P 500 would generally be considered high: on an individual basis they are traded frequently and in large quantities. More exotic ETFs – like the ProShares Bitcoin Strategy ETF – would be considered less liquid in this regard, as it’s arguably harder to trade in and out of the underlying assets.
Finally, consider the bid-ask spread of any ETF you are looking to invest in.
Overall, a more narrow or tight bid-ask spread signals increased liquidity in an ETF. According to Fidelity, a tight spread is considered anything below 0.10%.
How to automate ETF investing
Arguably the hardest part of investing over the long term is staying consistent when markets are choppy and the outlook uncertain.
With Syfe’s recurring buy feature, you can automate the process of investing in US ETFs – allowing you to stick to your investment strategy and smooth out volatility over the long term.
With recurring buys you can choose any US-listed ETF and set up a regular, automated investment process. Here’s the process:
- Download our app and create a Syfe account or login into the Syfe app on your mobile device
- Search for the ETF you’re looking to invest in and tap the recurring buy icon’
- Choose the dollar amount you want to invest on a recurring basis
- Select between a monthly or weekly frequency
- Select which date the investment repeats on
- Investing in ETFs represents a simple and low cost way to diversify your investment portfolio
- When looking at which ETF to invest in you should consider the management fees of the ETF, the long term returns of the underlying benchmark it tracks, and the management style of the ETF
- Thematic ETF investing allows investors to access a range of unique and exciting financial products
- While past returns are no guarantee of future returns, ETFs that track broad-based indexes like the S&P 500 and the ASX 200 have performed well over the long term
This article/webinar is brought to you by Syfe Australia Pty Ltd, AFS representative number 001295306 representing Sanlam Private Wealth Pty Ltd (AFSL 337927). Any information contained here is factual and should not be construed by you as financial product advice. You should consider obtaining independent advice before making any financial decisions. Any reference to an investment’s past or potential performance is not an indication of any specific outcome or profit. We do not intend for any statement made here to relate to the acquisition or disposal of any shares in the companies or other financial products named here.