Interest in exchange-traded funds is increasing among investors looking for new ways to make money.
The amount invested in such funds has risen almost threefold over the past five years and now stands at £304billion, according to new research for The Mail on Sunday by data collector Morningstar.
A key appeal is that these investments offer a cheap way to invest in either specific stock markets or asset classes such as commodities and bonds.
Increasingly popular: Interest in exchange-traded funds is increasing among investors looking for new ways to make money
Many people are put off by the fancy title but exchange-traded funds are fairly straightforward to understand.
The investment – which is usually abbreviated to ETF – is an index-tracking fund designed to track the performance of a market or asset. This could be anything from the FTSE All-Share Index to the price of gold. The funds are listed on the London Stock Exchange and are traded just like any other share.
As with traditional shares you buy and sell them through an investment broker or by using an online platform run by firms such as AJ Bell, Halifax, Hargreaves Lansdown and Interactive Investor.
Like other shares, ETFs can also be bought inside a tax-efficient individual savings account (Isa) or held in a self-invested personal pension (Sipp).
ETFs tend to be cheaper for investors than actively managed unit trusts, open-ended investment companies (Oeics) or investment trusts.
This is because they do not require a fund manager to look after your money – a computer does all the investment work.
Annual charges on an actively managed fund are on average around one per cent, compared to 0.4 per cent or less for an ETF. There is no stamp duty on purchases.
Analysis by research firm WM Company indicates that over 20 years, four out of five actively managed funds fail to beat the performance of comparable index-tracking funds. So the odds are in your favour if you do not pay for a fund manager but follow a market using an ETF.
Jason Hollands, a director at wealth manager Tilney, says: ‘Much of the recent innovation in the investment industry has taken place in exchange-traded funds. Although they have been traditionally aimed at professional investors these funds have opened up investment opportunities in fascinating niche markets. These include cautiously managed US stocks and commodities such as gold.’
The ETFs he currently recommends track the performance of the 1,000 largest listed companies in the United States (Invesco FTSE RAFI US 1000); an index of US companies that have grown their annual dividends for at least ten years (S&P Global Dividend Aristocrats); and the price of gold (Invesco Physical Gold).
Know the facts: ETFs tend to be cheaper for investors than actively managed unit trusts
Over the past five years, these three funds have turned £1,000 into £1,930, £1,550 and £1,250 respectively. The annual charges are 0.39 per cent, 0.45 per cent and 0.29 per cent. Hollands says: ‘It is in unusual markets or asset classes where an ETF really comes into its own – often offering the cheapest way to get involved.’
He adds: ‘Thanks to the competitive pricing of ETFs, some other index-tracking funds – run in the form of a unit trust or investment fund – have lowered their charges.’
So, Fidelity Index, that replicates the performance of the FTSE All-Share Index, and Vanguard FTSE 100 Index that tracks the index of the country’s biggest listed companies, both levy an annual fee of 0.06 per cent. FTSE 100 ETF iShare Core FTSE 100 has a slightly higher annual management charge of 0.07 per cent.
Morningstar says there are now more than 900 ETFs listed on the London Stock Exchange – nearly 50 per cent more than five years ago.
Among the main providers of ETFs are iShare – owned by giant fund manager BlackRock – and PowerShares, part of Invesco.
Leading fund platforms such as Interactive Investor and Hargreaves Lansdown levy dealing charges on ETFs for ‘occasional traders’ of £10 and £11.95 respectively – the same as for shares.
If you opt to hold the ETF in an Isa or a Sipp via a funds platform, you will pay additional fees. With Hargreaves Lansdown there is a 0.45 per cent annual platform charge for Isas. For Sipps, Hargreaves levies a 0.45 per cent annual charge on the first £250,000, falling to 0.25 per cent on portfolios above this figure.
Morningstar says there are now more than 900 ETFs listed on the London Stock Exchange
Wealth manager Seven Investment Management believes a good way for investors to dip their toes into the ETF market is via a ready-made portfolio. It offers a range of so-called asset allocated passive options that are invested in ETFs.
Ben Kumar, investment manager at Seven, says: ‘An ETF is often the most cost-effective way to get exposure to unusual sectors or assets. By combining ETFs with other funds you get better value for money.’
Among the ETF-invested options provided by Seven is the Balanced AAP fund. This has an annual charge of 0.62 per cent and has turned £1,000 into £1,239 over the past five years.