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ETF beginner guide: What are ETFs?

What are ETFs? Get to know the benefits and risks of investing exchange-traded Funds (ETFs), who are suitable for investing ETFs and how to choose the right ETFs for you! This ETF beginner guide is going to introduce the popular Hong Kong ETFs and US ETFs, how to buy ETFs and best stock broker to use.
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ETF 101

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What are ETFs?

Exchange-traded Funds (also known as ETFs) are the types of fund that holds multiple underlying assets, making it a great way for investors to gain exposure to a pool of investments without the need to buy each one individually. ETFs can be structured to track anything from a particular index like the FTSE 100 to market performance, and from sector, commodity, to other asset, such as government bonds.


Considered as “passive” investments, ETFs attempt to track the performance of a market index or pool of investments rather than trying to beat the index. Investors will experience a similar return or loss as the index tracked. When money is invested in an ETF, new shares will be issued. When money is withdrawn from the ETF, units will be redeemed. The ability of an ETF to create and redeem shares keeps the market price of ETFs in line with their underlying assets. ETFs can be purchased or sold on a stock exchange like a regular stock.


Most Popular ETFs: HK ETFs and US ETFs

Popular Hong Kong ETFs

  1. Tracker Fund of Hong Kong Ltd（02800): designed to provide investment results that closely replicate the performance of the Hang Seng Index
  2. CAM CSI300（03188): aim to replicate the CSI 300 Index
  3. HSCEI ETF（02828): seek to match as closely as practicable the performance of theHang Seng China Enterprises Index

    Popular US ETFs

    1. VOO: tracks the S&P 500 index by owning all of the equities within the S&P 500
    2. ROBO: tracks a basket of robotics stocks from around the world
    3. QQQ (Invesco QQQ Trust): tracks the Nasdaq-100 Index including the 100 largest non-financial companies listed on the Nasdaq
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    Advantages of ETFs

    Transparent

    Unlike mutual funds, ETFs are transparent - it will show you the underlying investments, which is not always the case when you invest in mutual funds.

    Diversifying your portfolio

    With just one holding of an ETF, the investors are exposed to a wide range of investments such as the top 500 large-cap companies in United States, to global bonds and even commodities like gold. For example, by investing in gold ETFs, you do not need to physically possess gold in order to invest in gold per say, making it a lot easier to diversify your investment portfolio and access a wide range of investment products.

    Cost-efficient

    ETFs unlock diversification for investors given the multiple holdings, spreading the risk of your investments. For example, if you buy an ETF that tracks the S&P 500, it is just like buying a small part of each of the index’s 500 companies but at a much lower cost considering the commission fees charged for each trade and the capital required.
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    Disadvantages of ETFs

    Tracking error

    ETFs may not track an index accurately as it does not always hold every asset in the index it is trying to track, resulting in a tracking error between the ETF’s performance and that of the index.

    Currency risk

    ETFs traded in a different currency can expose you to currency risk. The exchange rate movements may affect the value of shares that are bought and sold in that currency. For example, if you buy an ETF that invests in Japanese stocks, you will see the value of your ETF change not only if the price of the stocks changes, but also if the exchange rate between HKD and Yen changes.

    Vulnerable to market volatility

    All investments carry risks and ETFs are no exception. It is important to know that investing in ETFs does not necessarily guarantee returns. It could result in loss if the broad market index e.g. S&P 500 that it tracks is down so it is still vulnerable to market volatility.
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    Types of ETFs

    There are different types of ETFs available in the market, including the most commonly seen ones like passive ETFs, actively managed ETFs, leveraged ETFs, and inverse ETFs:

    Passive ETFs

    Replicate the performance of a broader index e.g. S&P 500 or a more specific targeted sector or trend.

    Actively managed ETFs

    Have portfolio managers making decisions about which securities to include with an aim to beat the market performance.

    Leveraged ETFs

    Seek to return some multiples (e.g., 2× or 3×) on the return of the underlying investments.

    Inverse ETFs

    Attempt to earn gains from stock declines by shorting (selling) stocks. It's a good alternative to short selling.

    Who is ETF for?

    As there will be brokerage commissions involved every time you trade, ETFs may be better suited for a buy-and-hold investor or someone who does not wish to actively manage their investment portfolio or who wish to access a particular investment but find it difficult to e.g. gold.

    How to buy ETF?

    Step 1

    Create a brokerage account

    ETFs can be traded through online brokers. A brokerage account allows you to trade ETFs, stocks and other investment products.
    Step 2

    Fund the account

    After you have created a brokerage account, you will need to fund the account before you can start investing in ETFs. Usually, you can fund your brokerage account in different ways, but the exact way will depend on the broker.
    Step 3

    Search for ETFs

    After funding your account, you can search for ETFs and trade in the same way that you would do for shares of stocks.
    Step 4

    Confirm and purchase

    Check carefully the amount that you would like to purchase and then confirm to complete your order.

    ETF vs mutual funds

    ETF vs mutual fundsETFMutual Funds
    ETF vs mutual fundsCommissionsETFLower (usually only charge brokerage exchange commissions and platform fee (if any))Mutual Funds Higher (usually charge agent commissions)
    ETF vs mutual fundsTransparencyETFHigherMutual Funds Lower
    ETF vs mutual fundsInvestment costETFLowerMutual Funds Higher
    ETF vs mutual fundsManagement styleETFPassiveMutual Funds Active
    ETF vs mutual fundsFlexibilityETFHigherMutual Funds Higher

    What are the fees and charges for ETFs?

    Unlike mutual funds, ETFs do not normally charge a load. Since ETFs are traded directly on an exchange, brokerage commissions are usually incurred. It is important for investors to compare the brokerage fees, which can become an issue if an investor deposits small amounts of capital on a regular basis into an ETF leveraging on the "dollar cost averaging strategy".

    Further reading

    Looking to read more investment and wealth management related articles? Look no further:

    FAQ

    What are ETFs made up of?

    ETFs can be structured to track anything from a particular index to a market or any commodity.

    What is ETF bitcoin?

    A bitcoin ETF tracks the value of Bitcoin through a basket of assets.

    What's the difference between an ETF and a mutual fund?

    ETFs are usually passively managed whereas mutual funds are usually actively managed.

    What types of ETF can I buy?

    There are many types of ETFs available in the market such as stock index ETFs, commodity ETFs, inverse ETFs and leveraged ETFs.

    Why is the market price sometimes different from the net asset value (NAV) of an ETF?

    The changes in the supply or demand for an ETF might affect the price of an ETF from the NAV of the ETF.