Exchange-Traded Funds For Dummies Cheat Sheet (Australia/New Zealand Edition) - dummies
Cheat Sheet

Exchange-Traded Funds For Dummies Cheat Sheet (Australia/New Zealand Edition)

Investing using exchange-traded funds (ETFs) in Australia and New Zealand is made easier when you understand the benefits of this investment product, what to look out for, how to invest in overseas ETFs — especially U.S.-based ETFs — and which websites to access for more information.

Investing in Exchange-Traded Funds in Australia and New Zealand: The Basics

An exchange-traded fund (ETF) is designed to track the price movement of a chosen index such as the S&P/ASX 200 in Australia or the NZX 50 in New Zealand. Typically, an ETF is made up of a basket of stocks that closely match the index the ETF is following.

ETFs can also track the price of a single commodity, such as gold or silver. Not all ETFs are created equal, though. Before you dive in, you need to know what you’re investing in and the risks and benefits of each type of ETF.

ETFs track an index in one of three ways, each with different characteristics:

  • Physical holdings: The ETF invests in the underlying stocks of an index and the ETF’s performance largely matches the index.

  • Synthetic replication: The ETF uses futures and options to track an index’s performance, without actually owning the stocks in the index.

  • Optimised sampling: Only the major stocks in an index are owned directly — the idea being that you don’t need to own all the stocks in an index to achieve the same performance.

At first glance, an exchange-traded fund (ETF) may seem identical to a managed fund. After all, like ETFs, managed funds also represent baskets of stocks or bonds. The two, however, are not twins. They’re not even siblings. Cousins are more like it. Here are some of the big differences between ETFs and managed funds:

  • ETFs trade differently. They can be bought and sold, and their price changes, throughout the day. In contrast, managed funds are typically not listed on the Australian Securities Exchange (ASX) or New Zealand Stock Exchange (NZX). You have to contact the fund manager directly (or your financial adviser can do it for you) and usually complete a form to buy or sell managed fund units. The price you receive is the value of the fund at the close of business that day.

  • ETFs are cheaper. They require you to pay small trading commissions, but ETFs usually wind up costing you much less than a managed fund because the ongoing operating expenses are usually much less. Most ETFs charge no more than one-half of 1 per cent per year, some less than one-tenth of 1 per cent. New Zealand is the exception where ETFs costs range between 0.65 and 0.75 per cent per year.

  • ETFs tend to track indexes. Managers of ETFs tend to do very little trading of securities in the ETF. The vast majority of managed fund managers spend a lot of their time trading.

  • ETFs can result in less tax. Because of low portfolio turnover and also the way they are structured, ETFs’ investment gains usually are more gingerly taxed than the gains on managed funds.

The following table highlights the main similarities and differences between ETFs and managed funds.

Exchange-Traded Funds versus Managed Funds
ETFs Managed Funds
Priced, bought and sold throughout the day? Yes No
Offer some investment diversification? Yes Yes
Minimum investment required? No Yes
Purchased through a stock broker? Yes Sometimes
Do you pay a fee or commission to make a trade? Yes Yes
Can you buy/sell options? Yes No
Indexed (passively managed)? Typically Atypically
Can you make money or lose money? Yes Yes

Websites for Up-to-Date Information on Exchange-Traded Funds

The world of exchange-traded funds (ETFs) in Australia and New Zealand is forever changing. Keep updated by regularly checking in on any of the following websites:

  • ETFdb: A U.S. site with great, up-to-date information, and the world mapping tool is a great gadget that shows you how many and which ETFs cover countries and regions around the globe.

  • ETFmate: ETF Mate provides investors with general information on ETFs. Not a bad site to start your ETF journey.

  • Yahoo! Finance Exchange-Traded Funds Center: Features a search function with intimate details on individual funds, an ETF glossary, and regularly updated news and commentary.

  • Morningstar Australia: Morningstar Australia provides research on ETFs, managed funds and equities. Lots of free stuff is available but you have to pay for the good bits.

  • PennyWise: PennyWise Investment provides in-depth research, its own ratings, and asset allocation and portfolios using ETFs in Australia. You can access research on the website for free for four weeks and then you have to pay.

  • Smartshares: SmartShares is the main provider of ETFs in New Zealand. This site provides all the product information you need for five out of the six NZ-listed ETFs.

Investing in Overseas Exchange-Traded Funds

Over 3,700 exchange-traded funds (ETFs) are available globally, but only a small number of these (around 60) are listed locally in Australia or New Zealand. For this reason, Australian and New Zealand investors often need to look further afield to get greater choice and diversification for their ETF portfolios.

Regardless of which overseas market in which you choose to buy ETFs, the following applies to both New Zealand and Australian investors:

  • Find a stock broker who can invest in international markets for you. Most of the major brokers can do this for you, but charges and fees vary so do your research.

  • Research the ETFs available. Look at the overseas websites of the major ETF providers, such as iShares, Vanguard, PowerShares, StateStreet. ETF comparison websites from the US can help with providing independent views, as can the likes of research house Morningstar.

  • Investing overseas means currency risk — you can lose or make money on the currency depending on when you invest. You might find you make money on the ETF but lose money when you convert the profits into your home currency. Build currency movements into your returns.

  • Overseas ETFs, especially some listed in the US, can be pretty sophisticated — multiplying an index’s price movements by two or three times, for example. Some borrow money to invest and others move up in value when an index moves down (these funds are called short ETFs). Be careful: Some of these ETFs are designed more for gambling than investing.

  • Tax on overseas investments can be tricky to deal with. Not only are you likely to be taxed by the country in which your ETF is listed, but you may also be taxed on any gains or income in Australia and New Zealand. Buying shares in the US also means filling out a few more forms, declaring you’re an overseas investor and, hopefully, reducing the tax paid in the U.S. Check with an accountant or qualified finance professional before you invest.

  • For New Zealand investors, most Australian shares are exempt from Foreign Investment Fund (FIF) tax and taxed only on dividends, in the same way as New Zealand shares. This exemption applies to companies listed on an approved index of the Australian stock exchange, including the ASX All Ordinaries Index. This means New Zealand investors can use Australian ETFs as a legitimate part of their investment portfolio, bearing in mind the currency risks.

Putting Together an Exchange-Traded Fund Portfolio

Investing a small amount in an exchange-traded fund (ETF) can give you exposure to a huge range of equities and other asset types, such as property, commodities and bonds. Investing in four or five ETFs allows you to diversify your investments across a range of assets, sectors and international markets.

Using ETFs can enhance an existing portfolio in many ways. For example, if you have a small number of stocks in your portfolio, adding an ETF can help to diversify your holdings and potentially reduce risk without sacrificing returns. But it all depends on your attitude towards risk — specifically, how much risk you’re prepared to take on for the return you’d like.

Your attitude to risk affects your risk profile — whether your investment style is aggressive (high risk for potentially high returns), middle of the road or more conservative (low risk for lower returns). Working out your risk profile can be tricky — your profile changes over time and as your circumstances change. Everyone is different and, if unsure, you should speak to a finance professional to work out just how much risk you can handle — the results may surprise you!

A guide to a spread of ETFs for different risk types is shown in the following table.

ETF Type Aggressive Middle-of-the-road Conservative
An ASX 200 ETF/NZX10 ETF 20 to 30% 20 to 30% 15 to 20%
An ASX small ordinaries ETF 10 to 15% 5 to 10% 0 to 5%
A European or global ETF 15 to 25% 10 to 20% 5 to 10%
A US ETF 10% to 15% 5 to 10% 0 to 5%
An Emerging Markets ETF 5 to 10% 0 to 5% 0%
A fixed interest managed fund 0 to 5% 15 to 25% 40 to 60 %

Building a diversified portfolio of ETFs can reduce risk but not remove it. A portfolio of ETFs may even add risk depending on what returns you want to achieve. The preceding table is only an example and does not take into account your personal circumstances. Speak to a professional adviser, work out your risk profile and figure out what ETFs suit your style.