ETFs and ETCs
Both ETCs and ETFs combine the diversification offered by unit trusts with the simplicity of shares.
What are ETFs and ETCs?
Exchange Traded Funds (ETFs) are index-tracking funds which are listed and traded on a stock exchange.
Exchange Traded Commodities (ETCs) are simple and transparent securities that enable investors to gain exposure to commodities without trading futures or taking physical delivery.
What are the benefits?
- Lower costs - In April 2014 Stamp Duty was abolished on ETFs, so investors benefit from reduced costs.
- Liquidity - Continuous pricing enables investors to trade quickly and efficiently.
- No Minimum Investment - Allows even the smallest portfolios to achieve broad diversification.
- Shorting opportunity - The potential to make money even in a falling market.
What are the risks?
- Investments and income arising from them can fall in value and you may lose some or all of the amount you have invested.
- ETCs may not be physically backed, these are referred to as synthetic ETCs and investors should be aware that they carry additional risk. This is because the fund does not have possession of the underlying commodity and instead uses derivatives to gain exposure, meaning there is more chance of a tracking error.
How can they be used?
- Rebalancing portfolios and adjusting investment strategy
The flexibility and range of products available means asset allocation and strategy decisions can be executed quickly and cheaply. An investor is able to achieve broad exposure to equity, bonds and overseas markets. Subsequently, rebalancing can take place in just a couple of transactions.
- Core / Satellite strategy
ETFs and ETCs can be used to build well diversified portfolios. Obviously, investors cannot be expected to follow every instrument in every market. Using these products, investors are able to adopt different investment strategies to suit their requirements. The core and satellite approach has proved very popular.
The Core is made of securities based on traditional benchmarks such as the FTSE 100 or S&P 500. These passively managed holdings will account for the majority of the investments, are considered essential to the structure of the portfolio and will rarely be changed.
The Satellite in contrast is built of more actively managed securities which an investor will use to specialise in certain, topical areas with a view to enhancing returns.
Asset allocation is key for investors and the WMA Balanced Index indicates that balanced portfolios should be circa 10 per cent exposed to alternative asset classes. ETFs and ETCs can be used to improve diversification by ensuring coverage of areas of which the investor has little specialist knowledge or expertise.
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ETF Fact Sheet (PDF)
ETC Fact Sheet (PDF)
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