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Army September 15, 2011
EXCHANGE Traded Funds (ETFs)
have become popular with inves-
tors and they are often promoted
as an easy way to diversify your
investments, usually with lower fees than
traditional managed funds.
Be warned though: some ETFs are com-
plex and risky investments.
As ADF members know, higher potential
returns usually come with higher risks. You
need to understand the risks and keep within
a level you are comfortable with.
What are ETFs?
ETFs are promoted as a low-cost way to
get investment returns similar to a share index
or another underlying asset.
They are a type of managed investment
that can be bought and sold like shares,
through your stockbroker or online trading
The ETF usually tries to match changes
in the value of an equities index, but ETFs
are also available that offer exposure to
assets such as international shares, foreign
currencies and even precious metals.
Two types of ETFs
Most ETFs buy the shares and other invest-
ments that they are trying to match -- they are
known as standard or physical ETFs.
While you will not personally own the
shares the ETF buys, you will usually own
units or shares in the ETF.
Your main investment risk is the perfor-
mance of the ETF's underlying shares and
Another type of ETF, known as a syn-
thetic ETF, may or may not directly own the
Weigh up the risks on
Exchange Traded Funds,
says ASIC chairman
Greg Medcraft. ETFs explained
Photo by Cpl Aaron Curran
What you need to
know before investing
underlying shares or other assets and uses
complex products called derivatives and
swap agreements to track their performance,
In Australia, only a handful of synthetic
ETFs are available. They are required to
include the word synthetic in their title, so you
can easily identify them, and other rules have
been introduced to reduce some of their risks.
Risks to consider
These are some of the complex features,
which can apply to physical ETFs, synthetic
ETFs and sometimes both.
TRACKING ERRORS: Physical ETF pric-
es 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. The extent
of any tracking error with a synthetic ETF
depends on its specific features.
PRICING ERRORS ('gapping'): ASIC has
found examples of ETF prices quoted by
online stockbrokers that are significantly
above or below the value of the assets that
the ETF holds. The risk is that you might
pay far more than the ETF's assets are
worth, or sell ETFs at a price far below
the value of their assets.
OVERSEAS INVESTING: If the ETF
tracks international shares or other invest-
ments, there may be currency, tax and
COSTS: While ETFs have become known
for low costs, management fees vary
and there are other costs to consider. For
example, some ETFs' management fees
may be higher than the fees for an equiva-
lent (unlisted) index fund.
COUNTERPARTY RISKS: Synthetic
ETFs enter into contracts with third par-
ties, or counterparties. Your returns are
dependent on the counterparty being able
to honour its commitment to the ETF.
SECURITIES LENDING: Physical and
synthetic ETFs may use securities lend-
ing, transferring some of their assets (such
as shares) to other companies for a fee.
The risk is the borrower will not return
the securities as promised.
Finally, whenever you invest, remember
the importance of spreading your invest-
ments to control your risks.
• For more information before investing, go to www.
moneysmart.gov.au and search for ETFs.
• Email ASIC at ADFcolumn@asic.gov.au with topics
that interest you.
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