Learning about shares: Exchange traded funds great for the beginner

Olympic champ Barbara Kendall gets some advice from DAN DIVIDEND.

Barbara Kendall asks: There seem to be lots of investments other than shares that I can buy on the sharemarket. I'd like to learn about them. What's an exchange traded fund?


Dan Dividend responds: You're right - shares are just the tip of the iceberg.

Exchange traded funds (ETFs) are a good place to start, as these little-known investment products are great for people new to the sharemarket. Worldwide interest in ETFs is growing and a lot of people, myself included, are excited about them!

I'll cover what ETFs are and how they work then hand over to our guest NZX broker, Cam Watson from ABN Amro Craigs in Tauranga, to explain some of the benefits for investors.

Pop quiz. Do you like the idea of gaining diversification through investing in a range of companies? Does researching companies and picking stocks seem too hard? Would you like your portfolio to replicate a market index (a tool that tracks the performance of a group of companies, such as the NZSX 10) so you get returns very similar to those of the index?

If you answered yes to any of the above, ETFs could be for you.

ETFs are like managed funds in that a fund manager invests in shares on your behalf. But that's where the similarity ends.

ETFs track an index. They are a basket of shares made up in the same proportions as the shares in the selected index.

This means the manager buys and sells shares only when the make-up of the index changes; for example if a new company enters the index. ETFs are therefore "passive funds" as the manager does not actively make investment decisions.

To buy an ETF you place an order with your broker in the usual way, as ETFs are traded on the sharemarket just like shares. That's where the "exchange traded" part comes from.

NZX manages an ETF called the NZSX 10 Fund. It holds shares in the 10 largest New Zealand listed companies, reflecting the make-up of the NZSX 10 Index. There are also several other ETFs listed on the NZSX market.

So what's in it for you? Over to Cam. Cam says: The most obvious benefit of ETFs is diversification. You can invest indirectly in a range of companies by buying just one ETF.

The NZSX 10 Fund, for example, gives you a little slice of each of the top-10 New Zealand listed companies.

It's also easy to keep tabs on how your ETF investment is performing. Most major indices are published in the newspapers and in the sharemarket news on TV, so you can see the movement of your index at a glance.

ETFs are very cheap to own compared with managed funds, because you don't pay anyone to make decisions about your investments.

This enables ETFs to carry a very small annual management fee. With less frequent changes to the make-up of the fund, ETFs also pay less in brokerage. This all adds up to better returns for you.

There are also tax benefits with ETFs. As they are passive funds, ETFs have an Inland Revenue ruling stating they don't have to pay tax on their capital gains when they sell shares, unlike managed funds.

Investors get the full benefit of share price rises within the ETF. Dividends are also distributed back to investors.

That's not to mention their great performance. Most passive index funds have outperformed actively managed funds in the past. The United States-based Vanguard 500 Index Fund has beaten 80 per cent of managed funds since its establishment nearly 30 years ago. Research has shown that it is difficult for an active fund manager to beat an index fund after fees have been taken out.

ETFs in New Zealand have also shown great performance, with the NZSX 10 Fund finishing last year as one of the best performers of all NZ passive equity funds. It also rates among the top 15 per cent of all NZ equity funds over the past three years.

This all makes ETFs a handy little investment vehicle for the time- or information-deprived investor, and anyone who wants an easy way to diversify their portfolio and get returns similar to an index.

To find out more, talk to your NZX broker or email Dan Dividend.

NEXT: Dan Dividend looks at debt securities.