Exchange-traded funds (ETFs) are becoming increasingly popular in global financial markets because they offer a way to invest in stocks in a particular industry, product, or region. Which investors are ETFs suitable for? And what must you know about them before you start investing?
What is an ETF?
Exchange-traded funds (ETFs) are similar to investment funds (LAT). In both ETFs and traditional investment funds, the fund manager invests in various securities. The main difference, however, is that ETFs are traded on the stock exchange just like stocks.
The value of a fund's units is usually derived from the index to which they are linked (e.g., S&P 500, FTSE, energy commodities, technology, or commodities). Therefore, if the index changes, the price of the fund's units also changes.
For example, if you decide to buy fund units linked to the oil industry, when the price of oil changes, the value of the fund units should also change.
The origins of exchange-traded funds can be traced back to Canada, where they appeared as early as the 1980s. However, this financial instrument has become particularly popular in recent years, especially in the United States, where 140 new ETF funds have been created in 2021 alone.
How do ETFs work?
Depending on the type of activity, there are two main types of ETFs: passively managed ETFs and actively managed ETFs.
The manager of a passively managed exchange-traded fund observes the financial market activity from the side, without actively managing the asset fund. Such ETFs are linked to stock market indices such as the S&P 500, which consists of the 500 largest U.S. companies, and the MSCI Emerging Markets Index, which consists of stock indices of 24 emerging markets, or to several indices simultaneously.
To use the S&P 500 Index as an example. If you invest in an ETF linked to this index, the outcome will depend on the performance of all 500 companies. Many companies will do well, and others will do worse, but the index will reflect the average performance. On the other hand, if the index is linked to a commodity such as gold, the performance will depend on the fluctuations in the price of gold. So, the investor has a wide choice of ETFs linked to the industry or region in which he is willing to invest.
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Actively managed exchange-traded funds are not linked to a specific index or sector. Investments in these ETFs are actively managed by the fund manager to maximise returns. Therefore, the composition of the underlying assets that make up an ETF may change over time.
That is, the manager of active ETFs typically does not invest in all 500 companies included in the S&P 500, but selects individual companies, reviews the portfolio, and makes changes if he or she believes this will lead to better performance over the long term.
Because the manager of active ETFs is much more involved in the operation of the fund, this kind of ETF typically has a higher management fee than passive ETFs. Just like individual stocks or bonds, ETFs are traded on the stock market, and their price fluctuates throughout the day depending on supply and demand.
Available ETFs can be found on various websites, such as Yahoo, Morningstar, Financial Times u.c. and others. Please note that not all ETFs are available for purchase in Latvia.
To start investing, you must first open an investment account and then a securities account. Then, in the Internet Bank, open the Securities – Shares and ETFs section and select the desired ETF by name or by using the list of stock exchanges. Once you have selected the ETF, place an order to buy the fund shares.
What are the benefits of ETFs?
- ETFs allow you to respond quickly to market changes by buying and selling ETF fund shares when price and stock market trends are favourable to you.
- Diversification of investment risk – ETFs can consist of various financial instruments, such as debt securities, stocks, commodities, currencies, indices, etc. In addition, a specific sector or region can be selected for the ETF.
- The structure of the ETF is easy to check. You only need to look at the index to which the ETF is linked to understand its composition.
What are the risks associated with ETFs?
- Like other financial instruments, ETFs do not guarantee a specific return.
- Currency risk. When you invest in foreign currencies, you run the risk of incurring losses on those investments due to unfavourable changes in the exchange rates of various currencies.
- Because there is a very wide range of ETFs on the market (over 7,000 ETFs were available in 2020), it can be difficult for an inexperienced investor to choose the most appropriate fund.
- Depending on the ETF, there may be other risks, e.g. related to politics, taxes, indices, etc.
What fees are charged for investing in an ETF?
Likely fees for investing in an ETF include an order execution fee, a settlement fee, and a custody fee. There may be other fees (e.g., management fees or other fees specified in the ETF documentation) that are not paid directly because they are included in the price of the instruments.
Please also note that income from investments in financial instruments may be taxed. When using an investment account, taxes must be paid only if the amount of funds withdrawn from the investment account exceeds the amount paid in.
Before investing, we urge you to read carefully the investment recommendation document, which will explain why, in our assessment, the recommended investment fund is suitable for you, as well as the terms and conditions, information materials and fees related to the services provided and the recommended fund. Based on this information, you will be able to decide on your investments.
This material contains the information about AS "SEB banka" investment services or ancillary services. Investment products produce a return linked to risk. Their value may fall as well as rise, and historic results and/or returns are not reliable indicators to expect future result and/or returns and are no guarantee of future result and/or returns; n certain cases you may lose the invested sum. Where either funds or you invest in securities denominated in a foreign currency, changes in exchange rates can impact the return. You alone are responsible for your investment decisions and you should always obtain detailed information before taking them. More information about SEB's funds, investment services or ancillary services, is available on our website. The provision of investment recommendation to you is subject to the Advisory terms and conditions, so please read them carefully and consult the staff of the bank if you need to.
