ETFs: let’s find out what they are and how to invest in them

Exchange traded funds ( ETFs ) are investment vehicles that combine the characteristics of classic actively managed investment funds and listed equities, representing a popular choice among investors seeking flexibility and diversification.

What are ETFs?

ETFs are funds that replicate a benchmark index, such as the S&P 500 or the FTSE MIB, through passive management. They are traded on the exchange during market hours, with prices varying according to supply and demand.

By their nature, ETFs do not seek to beat the index, but to replicate its performance. Passive management also greatly reduces the cost of running the fund because all the structure of analysts and traders typical of active funds is unnecessary.

For example, imagine an ETF that tracks the S&P 500 index. If the S&P 500 rises by 5 percent, the value of the ETF will also rise by a similar percentage, since it replicates its composition without any traders having to do anything. Passive management indeed!

Why choose an Exchange Traded Fund?

Exchange Traded Funds, have many advantages that make them an attractive choice for investors. Some of the main benefits include:

• Diversification: ETFs allow you to reduce risk by investing in a wide range of stocks or bonds within a single product. This feature makes it possible to spread capital across several companies or sectors, minimizing the negative impact that a single security might have on the portfolio.
• Low fees: Due to their passive management, Exchange Traded Funds tend to have lower costs than traditional mutual funds. This means that investors can keep more of their earnings, as management fees are significantly lower.
• Trading flexibility: ETFs offer the ability to trade in real time, allowing investors to trade the market at any time during market hours. This feature allows them to react quickly to price fluctuations, thus optimizing investment opportunities.

Types of ETFs

ETFs can follow various indices or sectors. Here are some of the main types:

• Equity ETFs: replicate indexes such as S&P 500, Nasdaq, or Russell 2000.
• Sector ETFs: focus on specific sectors, such as technology, energy, or health care.
• Commodity ETFs: invest in gold, oil, or other resources.
• Bond ETFs: follow indices of government bonds or corporate bonds.
• International ETFs: invest in indices of specific countries or regions, such as the MCHI ETF, which replicates the Chinese market.

Pros and Cons of Exchange Traded Funds

Pros of ETFs	Cons of ETFs
Access to different sectors and markets: ability to invest in multiple sectors and geographic areas through one instrument.	Concentration Risk: some sector ETFs may limit diversification.
Reduced Management Costs and Fees: low management fees compared to other funds because they passively track an index.	Lack of liquidity: some ETFs with low trading volumes are less easily traded.
Portfolio diversification: allow you to reduce risk by investing in a diversified basket of securities.	Higher costs for actively managed ETFs compared to passive ETFs.
Continuous trading flexibility: ETFs can be bought and sold throughout the trading day, like stocks.	Tracking error risk: ETFs may not perfectly replicate the performance of the benchmark index.

How to invest in an ETF

Investing in an ETF is simple and requires just a few steps. Here is a beginner’s guide:

1. Choose a platform: Exchange Traded Funds are available from most online brokers. Simply register and deposit the necessary funds.
2. Select an ETF: Use an ETF search tool such as JustETF, which allows you to filter by yield, cost and sector.
3. Make the purchase: After selecting the ETF, you can purchase a number of shares of your choice based on available capital.

Popular ETFs

There are thousands of ETFs listed on various markets. You can use market capitalization as a selection criterion to identify the most popular ones.

As of today’s date (05/11/2024) the most capitalized ETFs are:

• iShares Core S&P 500 UCITS ETF USD (Acc): replicates the S&P 500® index or the 500 largest-capitalization U.S. equities.
  • ISIN: IE00B5BMR087
  • Ticker: CSSPX
• iShares Core MSCI World UCITS ETF USD (Acc): replicates the MSCI World index i.e., equities of 23 developed countries around the world.
  • ISIN: IE00B4L5Y983
  • Ticker: SWDA

• iShares Core MSCI Emerging Markets IMI UCITS ETF (Acc): replicates the MSCI Emerging Markets Investable Market (IMI) index i.e., emerging market equities from around the world.
  • ISIN: IE00BKM4GZ66
  • Ticker: EIMI

Conclusions

ETFs are a versatile and accessible tool that allows investors of all levels to gain diversification and flexibility. From beginners to experts, the ability to replicate specific sectors or global markets makes Exchange Traded Funds suitable for a variety of investment strategies. By leveraging an ETF, you can build a balanced portfolio with ease, accessing numerous assets without the burden of direct management.