What are Exchange-Traded Funds?
A Thorough Comparison & Analysis
Exchange-Traded Funds are a common investment option among investors, also known as ETFs.
An ETF is a passively managed investment fund traded on the stock market that only tracks the stock or commodity index. A professional fund manager invests this pool of money in stocks, bonds and other classes of assets on behalf of all investors.
For investors with only a small amount of funds to invest, these advantages are particularly helpful.
An ETF typically seeks to generate a return that tracks or replicates a particular index such as stocks index or commodity index. Hence, it does not aim to outperform the underlying index.
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Table of Contents
What are the differences between Exchange-Traded Funds (ETFs) and Unit Trusts (UTs)?
Before we start, you will need to understand the difference between both types of investment products as this is commonly confused between young investors.
How does ETFs work?
An ETF typically seeks to generate a return that tracks or replicates a particular index such as an index of stocks or commodity index.
Such index-tracking ETFs are managed passively by the ETF managers and do not seek to outperform the underlying index. Index tracking ETFs usually have fees and charges lower than those of actively managed investment funds such as Unit Trusts.
Why invest in ETFs?
There are several ETFs are available to choose from. If you buy a stock index tracking ETF, you will gain exposure to index performance. For instance, investing in a Straits Times Index (STI) tracking ETF offers investors exposure to the Singapore economy.
Types of ETF funds
An ETF can be structured differently, even though its investment objective is to track the same underlying index. Let’s find out what are the 2 differences type of ETFs below!
Cash-Based ETFs (or physical) are ETFs that directly invest in the resources to track the index.
- They can invest in: all the stocks, bonds or assets component of the index.
- A representative choice of shares, bonds or assets.
Synthetic ETFs are ETFs that use derivatives such as swaps or access products (e.g. participatory notes) to generate returns that track the indices.
- There are more parties engaged, such as the swap counterparty or the issuer of the access product.
- You are exposed to the risk that, under the swap or access product, the swap counterparty or access product issuer may default on its payment obligations. If it becomes bankrupt or insolvent, a party may default.
- The amount of loss you suffer will rely on the counterparty or issuer’s exposure to the ETF.
- On the SGX, Synthetic ETFs are marked with an ‘X’ appearing next to the ‘@’ marker used to label SIPs. You will see the ‘[email protected]’ symbols next to the trading title of the ETF.
The unfunded or financed structure may be used by synthetic swap-based ETFs. We will explain more about it below.
There are 3 types of synthetic ETF:
The ETF invests in participatory notes (P-notes) or other derivative instruments, replicating index performance in an access product-based ETF.
This structure was used in restricted markets such as China or India for indices. For example, the ETF may purchase and hold participatory notes linked to a basket of Chinese A-shares. As such, the ETF would be exposed to the participatory notes issuer’s counterparty risk.
The ETF purchases and holds a securities basket in an unfunded structure. The securities basket may be entirely unrelated to the index tracked by the ETF. The ETF then concludes a swap agreement with another entity known as the swap counterparty.
- The ETF will pay the return it earns to the swap counterparty from the securities basket.
- The swap counterparty pays the return of the index to the ETF.
The ETF passes its cash holdings (pooled funds from investors) to a swap counterparty in a funded structure. The swap counterparty will post collateral with a custodian of a third party. The securities that make up the collateral may not be linked to the tracking index of the ETF.
- The collateral shall be kept to offset the counterparty exposure of the ETF.
- The swap counterparty pays in return for the returns of the index tracked by the ETF.
How to buy ETFs
Ready to start investing in ETFs? You may want to consider STI ETF as it is a simpler way to invest in Singapore’s top 30 companies by just buying it! There are two approaches to buying STI ETF units. One is through a brokerage account, and the other is through a regular savings plan.
You first need a CDP account and a bank account to open a brokerage account. Your broker will help you in opening an account with the documents required.
You’d have to decide how much you want to invest in the STI ETF after your account is set up.
You can search for the STI ETF to place in a trade on your trading platform with a minimum entry of 1 lot. 1 lot is 100 shares, so if the STI ETF price is now $3.20, 1 lot will cost you $320 plus trading expenses and commission.
If you prefer not to invest a lump sum of money all at once, you can choose a monthly investment strategy(Dollar Cost Averaging) where each month you contribute a set quantity to invest through a regular savings plan.
However, this is not a real savings account, despite the name, and your cash is not 100% protected by principle with small risk is still being engaged.
You only need a minimum of $100 to start investing.
You can approach us to start your Regular Savings Plan as low as just $100/month!
How to choose ETF funds?
Generally, ETFs are chosen on the basis of Quantitative and Qualitative factors.
1. Quantitative Factors
Assets Under Management (AUM) is the total market value of assets held by an ETF.
- A bigger AUM implies: lower expense ratio as operating expenses are spread over a bigger asset base
- Higher liquidity as they are traded more frequently.
Liquidity is how simple or hard it is, without impacting its cost, to purchase or sell an ETF. This liquidity between buyers and sellers is very important in the secondary market.
Expense Ratio is what an investor pays to cover an ETF’s operating and management expenses, and is usually expressed as a percentage of the average net assets of an ETF.
Simply placed: the smaller the percentage of expenses, the greater the total return.
Tracking Difference is the difference between the results of an ETF compared to the index it tracks. Naturally, the lower the difference in tracking, the closer it tracks the exposure to the corresponding market.
2. Qualitative Factors
The factors are pretty straight forward which can be seen from the comparison image above.
When picking ETF funds, what you want is to have an ETF which can represent the overall market performance and to know the risk of the assets which it holds. There are 2 types of ETF funds which are mentioned earlier in this article.
What are the popular ETFs to investors in Singapore?
You may choose to invest in the 2 STI ETFs, namely the:
- SPDR STI ETF
- NIKKO AM STI ETF
Both are different fund house which manages the funds but mainly has similar holdings, which are basically the top 30 firms in Singapore. You may want to look into the funds SPDR STI ETF and Nikko AM STI ETF for more information on the companies.
Besides the 2 STI ETFs, you may also consider the below ETFs for your investing journey:
ABF Singapore Bond Index Fund allows you to access high-quality government and quasi-government bonds such as bonds issued by the Government of Singapore, the Housing & Development Board (HDB), the Land Transport Authority (LTA), Temasek and SP Power.
Lion-Phillip S-REIT ETF was one of three Real Estate Investment Trust (REIT) ETFs recently listed in Singapore. REITs are becoming more common in Singapore, which is increasingly seen as alternatives to investment in real estates.
SPDR S&P 500 ETF is subjected to the S&P 500 index stocks. The S&P 500 ETF is considered a country index, similar to the STI ETF. It provides you with a simple and trouble-free way to diversify your investments with up to 500 leading companies listed in the USA such as Apple, Facebook, Microsoft, Alphabet, Amazon and many more.
SPDR Gold Shares ETF invests in gold and has always been viewed as an excellent value store and is a common investor asset class. Investing in the SPDR Gold Shares ETF is a good workaround for many investors who want gold exposure, but don’t want the trouble to acquire and store gold assets physically.
How to evaluate ETFs performance and determine the price?
Exchange-Traded Funds (ETFs) are listed and traded on a stock exchange as open-ended investment funds. They strive to track the performance of an index (such as the Straits Times Index) or asset class (such as commodities). ETF pricing will be determined based on demand and supply, which is similar to stocks traded.
As mentioned earlier in the section above, “How To Buy ETFs – #1 Investing Through Brokerage Accounts”, the minimum investment for ETF will be 1 lot, which is 100 shares. If the STI ETF price is at $3.20, 1 lot will cost you $320 plus trading expenses and commission to start with.
Fees and charges
Find out about your financial advisor or broker’s transaction fees such as brokerage fees and clearing fees. Usually, there are no sales fees for ETFs.
However, there are certain fees that are payable to ETFs. These include charges charged to the ETF by the fund manager, trustee and other parties. While it is not the investor to pay these charges, the factors will influence your returns.
How to screen and filter for ETF funds?
If you’re new to invest, SGX has an ETF-screening platform ready to get you moving on shortlisting stocks that are worth looking at based on your needs. Within your shortlist, you can readily use this platform to compare distinct kinds of ETFs you are looking at, especially finding details such as Asset Class, Geography, Benchmark and Fund Manager’s Information.
Best of all, to use the platform, you don’t even need to sign up. Just go over to SGX ETF Screener.
Which is the best ETFs for me?
While our intention to invest is to generate profits, we also need to be intelligent in selecting the correct strategies that make sense to you. Here are some variables to consider before deciding on the investment strategy that works best for you.
1) Know how to identify and analyze – In order to be profitable in investment, you need to know how to identify and analyze ETF funds.
2) Diversification – to manage risk, you should look into what the ETF funds portfolio are investing. You should go for the ETF funds according to your desired risk-return profile.
3) Know your Risk Tolerance – before you start buying ETFs. Different types of ETFs have different risk. Investing in growth funds tends to be much riskier and usually most impacted when a recession hit. In contrast, value funds tend to be less risky (although not always).
4) Personal Interest – may also impact your stock investment strategies. For instance, if you’re someone who likes to read news linked to technology and enjoy checking out the recent products that can alter our world, then you may be naturally inclined to invest in technology businesses like Apple, Alphabet and Amazon.