AIA Queensland Committee Member and Chermside Equities Group Convenor, Rod Fraser recently gave a presentation to the Brisbane AIA group on Exchange Traded Funds (ETFs). In this first part of a series, he examines:

1. What are ETFs?
2. Who is involved in an ETF transaction?
3. Types of ETFs

What are ETFs?

ETFs are pooled investments that are listed on the stock exchange. They have low minimum investment amounts but buying even one unit offers diversification to small investors. Diversity is offered by strategy, geographic locations, asset class and sector or size of companies. Some ETFs have thousands of investments.

ETFs can be passive and follow an underlying index closely or actively managed where the portfolio manager aims to outperform an index.

Typically, ETFs disclose all of their holdings so they can be much more transparent compared to other managed funds. Fees are also low.

The first ETF was launched in the US in the 1990s.

In its Australian ETF Review, ETF issuer BetaShares found the industry ended July 2021 at an all-time high of $118.8B total market cap. The industry grew by 77% over 12 months, representing absolute growth of $51.6B over the period.

The ASX lists 199 ETFs and the Chi-X lists two.

Who is involved in an ETF transaction?

There are six parties involved in an ETF transaction:

1. ETF issuer – This is the company that issues the ETF. Some of the issuers in the Australian market include: BetaShares, Vanguard, iShares and VanEck.
2. ETF market maker – The market maker buys and sells ETF units to make sure there is enough supply to satisfy demand. They can create and redeem units which ensures ETF prices trade close to the net asset vale (NAV) of the fund. Market makers include: Citi Group and Morgan Stanley.
3. ETF custodian – The custodian holds the investments for the benefit of investors and is a separate entity to the ETF issuer. The structure makes sure investors risk is confined to the ETF’s investments and there is no exposure to the issuer. An example of a custodian is Perpetual Corporate Trust.
4. ETF index provider – Index providers track the prices of securities on a daily basis. They calculate returns over set periods and rebalance regularly. Two well-known index providers are S&P and MSCI.
5. An exchange – ETFs need an electronic exchange. In Australia, there are two exchanges – the ASX and Chi-X.
6. The investor

Types of ETFs

Source: visualcapitalist.com

Look out for Part 2 and 3 in the series in coming editions as Rod explains the key things he looks for in ETFs and how he calculates whether ETFs are priced above or below net asset value and thus an ETFs value given price.