Exchange Traded Funds (ETFs) are an efficient and low-cost way of investing in shares or other assets and have become one of the world’s most popular ways to invest. 

ETFs are managed funds that trade on an exchange like the ASX. You can trade ETFs in the same way you trade shares. The difference is that an ETF represents an investment in a basket of shares or bonds while a share represents an investment in just one company. An ETF’s basket could include a handful of shares or bonds or include hundreds. The shares or bonds contained in an ETF are usually determined by shared characteristics and a set of rules. For example, an ETF might include all the banks listed on ASX or it could include the top 25 global healthcare companies. 

ETFs have made available investment opportunities that were previously inaccessible for everyday investors. With ETFs, you can now easily access companies listed overseas like the tech giants Apple, Microsoft and Google (which are listed in the US). 

Some ETFs also give you low-cost access to investment strategies that are usually associated with onerous research or company analysis, for example, the consideration required to assess a company’s ethical or sustainability credentials. 

How are ETFs used for investing in Australia? 

There are now more than 360 ETFs in Australia, available via the ASX. Australian investors are increasingly using ETFs to invest in Australian companies, international companies, bonds and other securities. Over 1.5 million Australians invest in ETFs¹. 

Australian investors are using ETF investment strategies to build their portfolios and gain access to the multitude of markets, sectors and asset classes around the world via the ASX. Around 50% of ETFs on ASX provide exposure to overseas markets. 

Benefits and disadvantages of ETFs 

Advantages of ETFs 

Easy access 

Provide investors access to international markets, asset classes and investment strategies that were previously only available to institutional investors. 

Transparency 

With ETFs, you know what shares or other assets are in the fund, along with how they are selected for inclusion because ETF fund managers are required to publish holdings daily. In addition, because ETFs are listed on exchange they price throughout the trading day, and when you want to transact, you have full price transparency. 

Helps to reduce risk 

As your investment in an ETF is spread across a number of shares or other assets, it is considered less risky as you are not reliant on the growth of a single company or asset. 

Lower costs 

The management fees for ETFs are typically less than actively managed funds and less than the fees associated with investing in each of the companies directly. 

Saves time 

Most people do not have the time and/or expertise to be able to constantly research and track companies to identify suitable investment opportunities or know when to buy and sell that stock. An ETF eliminates much of that effort while still giving you access to a professionally managed portfolio. 

Tax benefits 

ETFs typically have lower turnover than active managers and therefore generate lower levels of capital gains tax liability. As with most things to do with tax, the benefits can be complex to explain, so we recommend reading our specific information sheet called Tax Advantages of ETFs for a more thorough explanation of the tax benefits of ETFs.  

Flexibility 

As ETFs trade on ASX, you can buy and sell ETFs at any time during the trading day, just like shares in individual companies. 

Potential disadvantages of ETFs 

Performance not guaranteed 

Like any investment, ETFs will not always increase in value. The performance of each ETF is determined by the performance of the companies, bonds or other securities held by the ETF. 

Loss of control 

Investors can’t pick which companies are in an ETF. ETFs track an index, and this index determines the companies, bonds or other securities included in the ETF. Investors do not have the option of adding or removing companies, bonds or securities. 

Types of ETFs 

There are many different types of ETF investments available on ASX. 

Australian ETFs 

With ETFs, you can access Australian equities, including large companies like CBA, Australian mid-caps and small-caps, as well as Australian bonds. 

International ETFs 

Invest in overseas companies or bonds, and access international markets and sectors via ETFs. Investors can access tech giants like Microsoft and Alphabet, multinational pharmaceuticals like Pfizer, and clean energy leaders like Denmark’s Orsted, all via the ASX. 

Sector ETFs 

With an ETF, you can focus your investment on a particular sector in Australia, like the big banks or access global sectors, like healthcare, resources, infrastructure, property and more. 

Dividend-focused ETFs 

Dividend ETFs focus on providing investors with regular dividend payments. These ETFs are popular with income-focused investors. 

ESG ETFs 

ESG ETFs, also known as sustainability ETFs, focus on companies that rate highly on environmental, social and governance (ESG) factors. 

Smart Beta ETFs 

Smart beta is the term given to ETFs (Exchange Traded Funds) which track an index that differs from the traditional market capitalisation approach of selecting shares, bonds or other assets. That is, smart beta ETFs take a “smarter” and more considered approach to what goes into the fund other than just the size of the company. 

Factor based ETFs 

Factor investing involves targeting companies or other securities that exhibit a specific characteristic. To be considered a “factor”, the characteristic must be important to explaining the risk and return of the company or security. Example of factors include value, quality, momentum and size. 

Commodity ETFs 

Commodity ETFs give you access to one or more type of commodity. This could include agricultural products like wheat and livestock, energy like oil and gas, and metals like gold and lithium. 

Bond ETFs 

Also known as fixed income ETFs, bond ETFs provide a portfolio of bonds. These could include a specific type of bond like Australian Government bonds, floating rate bonds, corporate bonds, US Treasury Bonds or other types of bonds. 

Property and infrastructure ETFs 

These ETFs provide access to a portfolio that focuses on listed property assets or listed infrastructure companies. 

ETFs vs managed funds vs index funds 

Defining ETFs, managed funds and index funds 

A managed fund 

A managed funds is a type of investment where your money is pooled together with other investors. A fund manager is then responsible for buying and selling assets to increase the value of the pooled money. There are many different types of managed funds. In the US, these are known as mutual funds. 

Managed funds can be broadly categorised by: 

1. The way investors can access the fund. Managed funds are either: 

• Listed on a stock exchange; or 

• Unlisted, meaning investors have to fill out forms to apply to buy into and sell out of the fund. 

2. How assets are selected. Managed funds either: 

• Rely on a person or team to decide where to allocate money and what assets to invest in. This is known as active management because the fund manager or team of managers is actively choosing the assets to invest; or 

• Follow an index which outlines the set of rules or criteria for what the fund invests in. This is known as passive management. 

So, index funds are simply a fund that tracks an index. Index funds can be listed or unlisted. ETFs are listed index funds. 

ETFs are a type of managed fund that track an index and are easily accessible because they are listed on an exchange just like shares. ETFs have the added benefits of being transparent because holdings are published daily, are generally more liquid and have lower costs than actively managed funds. 

Comparing ETFs and unlisted managed funds 

ETFs offer many advantages over unlisted funds. This includes ease of access, ability to see holdings and typically lower costs. 

ETFs offer many more advantages over actively managed funds. This includes removing emotional biases and subjectivity that occurs when humans make investment decisions, as well as “key man risk” referring to the tendency for actively managed funds to rely on a single person to make investment decisions. If that person leaves the fund manager, the associated intellectual capital and talent also departs the fund. 

In addition, according to the S&P Dow Jones semi-annual SPIVA Australia Scorecard, the vast majority of actively managed funds underperform their benchmarks over the short term (1 and 3 years) and long term (5, 10 and 15 years). This means investors in these funds are typically paying higher fees than ETFs and their fund is likely to be underperforming.