Investing in ASX exchange-traded funds (ETFs)

Exchange-traded funds, or ETFs, are gaining popularity with Australian investors. In 2001, there were only two ETFs listed on the ASX. Today there are more than 200.

Investors like ETFs due to their instant diversification and ability to give investors exposure to specific industries and themes. Let's take a closer look at investing in ETFs, their benefits and disadvantages, and some of the top ETFs on the ASX. 

What are ASX exchange-traded funds? 

An exchange-traded fund is a managed fund traded on the ASX like a share. The fund holds a basket of stocks or securities and will often track a particular index. 

ETFs can be structured to track anything from the price of certain commodities to the performance of shares in a specific sector. There are ASX exchange-traded funds that track the value of fixed-income securities, domestic and international shares, commodities, and cryptocurrencies. 

ETFs have exploded in popularity over the past 20 years due to their ability to give investors instant, diversified exposure to international and ASX shares, small, mid, and large capitalisation companies, currencies, commodities, and themes such as technology and sustainable investment. 

Most Australian exchange-traded funds are passive investments that seek to track the value of an index. The value of the ETF will rise and fall with the value of the index or asset it tracks. 

These are passive ETFs, types of index funds. An active ETF, by contrast, is more akin to an actively managed fund, albeit one traded on the Australian Securities Exchange. An actively managed ETF has a manager or team making active investment decisions. 

Why invest in ASX ETFs? 

Investors can spend hours trying to decide which shares to buy. The aim is to purchase shares that outperform compared to their industry or the broader market.

But research suggests your most crucial investment decision is how you spread your money between each asset class, such as Australian and international shares and fixed income. Investing via ETFs allows you to invest in the market as a whole or a specific segment. You can invest in equity, commodity, index, or sector-specific ETFs. 

This enables a big-picture approach to investment and avoids the need for you to pick individual shares. Because ETFs hold a basket of securities, they provide investors with instant diversification and can provide income and capital growth returns. 

Top exchange-traded funds on the ASX

Vanguard Australian Shares ETF

This ETF provides exposure to the top 300 companies listed on the ASX by market capitalisation. It seeks to track the returns of the S&P/ASX 300 Index (ASX: XKO), which comprises shares in various industries, including banking, mining, healthcare, and consumer goods. Top holdings include BHP Group Ltd (ASX: BHP), Commonwealth Bank of Australia (ASX: CBA), and CSL Limited (ASX: CSL). 

VanGuard MSCI Index International Shares ETF

This ETF seeks to track the performance of the MSCI World ex-Australia (with net dividends reinvested) in Australian dollars before taking into account fees, expenses and tax. The ETF provides exposure to many of the world's largest companies in major developed countries. Top holdings include Apple, Inc (NASDSQ: AAPL), Microsoft Corp (NASDAQ: MFST), and Amazon.com. Inc (NASDAQ: AMZN). 

iShares S&P 500 ETF

This ETF seeks to track the investment results of an index composed of large-capitalisation United States equities. The ETF provides exposure to large, established US companies. Top holdings include Apple, Microsoft, Nvidia Corporation (NASDAQ: NVD), and Tesla Inc (NASDAQ: TSLA). 

What to look for when buying ASX ETFs 

For investors, buying ETFs can be a smart and low-cost strategy to build a portfolio. Although they offer significant benefits in diversification and ease of investing, not all ETFs are created equally. 

The ETFs you choose must align with your investment strategy and goals. ETFs can provide broad market exposure or exposure to subsections of the market. They can cover different industries, investment styles, and themes. Generally, the less 'niche' an ETF is, the lower its fees will be. 

Because of the breadth of ETFs available on the ASX, the first thing you need to do as an investor is narrow your focus to those most suited to your financial goals.

Figure out whether you want an Australian ETF or an international ETF. Assess whether you want broad market exposure or exposure to specific industries or investment themes. Compare the coverage and fees of your different options. 

The ETF market has become more competitive in recent years, largely benefiting investors by driving costs down. 

Take note of the level of assets an ETF has — if it is below a certain level, it may have a limited degree of market interest. This can result in poor liquidity. The ETF needs to be traded in decent volumes daily. Some ETFs change hands infrequently, meaning less liquidity and broader buy-sell spreads. This is particularly important when you are seeking to exit an investment. 

Pros of investing in ETFs

Diversification: Investing in an ETF allows you to buy a basket of shares or assets in a single trade. For many investors, it would be uneconomical to buy each of the shares or assets an exchange-traded fund holds individually. Australian ETFs can also be utilised to access markets that may be difficult or expensive to invest in directly. Individuals who invest in ETFs are not required to engage in share trading, as the ETFs hold the underlying assets.  

Low cost: ETFs charge investors management fees. However, these are usually lower than those charged by actively managed funds. Lower fees allow for higher returns. 

Ease of trading: You can trade ETFs on the ASX just like shares. This means you can buy and sell interests in ETFs anytime during ASX trading hours. The brokerage you pay for trading depends on your broking service. Still, brokerage fees for buying and selling exchange-traded funds are generally similar to buying and selling individual shares. 

Transparency: Exchange-traded funds typically publish their net asset value (NAV) daily. The NAV is the value of the fund's assets minus any liabilities divided by the number of shares outstanding. It is calculated based on the most recent closing prices of the securities held by the fund. The NAV can help you monitor the performance of the fund's underlying assets.

Cons of investing in ETFs

Liquidity risks: Where a fund invests in assets that are not particularly liquid, it can sometimes be difficult for the ETF provider to redeem or create securities. Different exchange-traded funds can have different liquidity profiles depending on their underlying investments and how much the ETF is traded. Essentially, the more liquid an ETF is, the easier it will be to buy and sell securities in the ETF without moving the price. 

Currency risk: Many exchange-traded funds in Australia invest in assets offshore, such as US stocks. This means returns are impacted not just by the underlying asset performance but also by movements in currency values. Certain funds are 'currency hedged', which can help manage this risk. 

Market risk: ETFs can give inventors access to markets as a whole, such as the S&P/ASX 200 Index (ASX: XJO) or specific sectors, such as technology or healthcare. Either way, it is possible for the market as a whole to fall or for a specific sector to take a tumble. If this happens, the ETF investment's value will also fall. 

Are ASX ETFs a good investment? 

Exchange-traded funds offer many benefits to investors, including diversification, broad or targeted investment exposure options, low fees, and transparency. Many investors utilise ETFs as the building blocks of their portfolio, perhaps adding exposure to specific shares they view favourably. 

Whether investment in an ETF is suitable for you will depend on your investment goals and financial situation, as well as the attributes of the specific fund. 

You don't need a lot of capital to start investing in ETFs, which makes them a good way to get started on your investment journey. Today, the ETF investor has more options than ever before, meaning the individual investor is spoiled for choice.