Exchange traded funds

WITH HIGH LEVELS OF INFLATION AND RELATIVELY LOW RATES OF RETURNS ON CASH DEPOSITS, IT IS IMPORTANT TO MAKE SURE YOUR MONEY IS WORKING HARD FOR YOU. MARK QUINN AND DEBRAH BROADFIELD LOOK AT ‘ REAL’ INVESTMENTS – ASSETS THAT ARE EXPECTED TO GROW ABOVE THE RATE OF INFLATION a highly diversified basket because you have 500 different underlying investments but the top ten holdings make up around 35% of the value of the 500. The risk is very skewed to the big tech firms such as Google, Apple and Meta.

MAKE YOUR MONEY WORK HARDER Whilst you can purchase individual investments direct, most investors choose to invest through a collective investment where you pool your money with other investors into a larger pot and appoint a fund manager to run this pot for you – in doing so, your combined value is larger and you can spread your investments much more widely, which reduces risk. For example, the Vanguard LifeStrategy fund has approximately 22,000 underlying holdings.

Another example of skewed risk is the MSCI World Index tracker. Although ‘world’ would suggest a globally diversified portfolio, around two thirds are invested in the US alone.

‘ACTIVE’

VERSUS ‘PASSIVE’ MANAGEMENT

The Active investors appoint a fund manager such as Fidelity or BlackRock to run the fund on their behalf and pay the manager a fee, typically between 1–2% per annum.

The alternative is to simply buy a basket of investments through a ‘tracker’ or passive fund – in this way, your fund will grow in line with the performance of the investments within the basket and do not have the personal involvement (and cost) of a fund manager overseeing the fund.

Examples of common trackers are those that mirror the S&P500 or FTSE100 indices, which are the largest companies trading on the US and UK stock markets respectively.

Counterparty risk – there are different ways of tracking the market. The most secure is ‘physical replication’ whereby the tracker simply holds the underlying investments of the index it tracks i.e. if you buy a FTSE 100 tracker, you will simply hold the 100 shares that make up that index.

The other main way is ‘synthetic replication’, which means the index is tracked by using a complicated financial product supplied by another financial institution. In this situation, you have to think about the additional risk of that counterparty’s financial strength.

Other important points to have clear knowledge of are:

The size of the fund

The ETF’s domicile status

More Money In Your Pocket With

ETFS Exchange Traded Funds (EFTs) are tracker funds that trade on a stock market and the major advantage is the extremely low fees, with annual charges on some ETFs as low as 0.01%. The savings in fees compared with active fund managers can make a substantial difference to the value of your investments over time.

As ETFs are traded in real-time on a stock exchange, they can be accessed quickly, with low costs, and they offer access to a wide range of investments, from shares, gold and commodities to AI and environmental funds.

THE DEVIL IS IN THE DETAIL Whilst ETFs certainly have a place in a well-diversified portfolio, there are important considerations when selecting them.

Tracking error – as the sole job of the ETF is to follow the index it is tracking; you must ensure it is following the market accurately. If it fails to track the market it could result in underperformance, and this can be more costly than the fee saving on the management fee.

Skewed risk – be careful that your portfolio is sufficiently diversified; for example, you may think that the S&P500 is

The ETF’s tax residence Income treatment

Currency of the ETF

In short, although ETFs and tracker investments are simple in principle, there are important nuances of which to be aware, especially when considering cross-border investment.

ASK THE EXPERTS

Debrah Broadfield and Mark Quinn are Chartered Financial Planners (level 6 CII) and Tax Advisers (UK ATT) with 20 years of combined experience advising expatriates in Portugal on cross-border financial and tax planning issues.