ETF 101: A Basic Guide to Exchange-Traded Funds July 10, 2024

What is an ETF?

An Exchange-Traded Fund (ETF) is a type of investment fund that trades on stock exchanges, much like individual stocks. ETFs hold a basket of assets such as stocks, commodities, or bonds, and typically operate with an arbitrage mechanism designed to keep their trading prices closely aligned with their net asset value (NAV).

Passive vs Active ETFs

ETFs can be broadly categorised into two types: passive and active.

Passive ETFs, also known as index ETFs, are designed to track a specific index or benchmark, such as the Straits Times Index or the S&P 500.

Active ETFs, on the other hand, are managed by fund managers who make decisions on asset allocation and security selection, with the aim of outperforming a specific benchmark or index.

Here’s the quick side by side comparison

Advantages of ETFs

ETFs offer several advantages over other investment vehicles, including:

• Diversification: ETFs provide instant diversification by holding a basket of assets, reducing the risk associated with investing in individual securities.
• Cost-effectiveness: ETFs generally have lower expense ratios compared to actively managed unit trusts, making them a more cost-effective investment option.
• Liquidity: ETFs can be bought and sold throughout the trading day on stock exchanges, providing investors with greater liquidity compared to unit trust.
• Transparency: The holdings of most ETFs are disclosed daily, providing investors with visibility into their investments.

Disadvantages of ETFs

While ETFs offer numerous benefits, they also have some potential drawbacks:

• Tracking error: There may be a difference between the performance of an ETF and its underlying index, known as tracking error. This can be caused by factors such as fund expenses, trading costs, and rebalancing activities.
• Trading costs: Although ETFs are generally more cost-effective than unit trusts, investors may still incur trading commissions and bid-ask spreads when buying or selling ETF shares.
• Potential liquidity issues: Niche or thinly traded ETFs may have lower trading volumes, leading to wider bid-ask spreads and potentially higher trading costs.

How to Choose an ETF

When selecting an ETF, investors should consider the following factors:

• Expense ratios: The ongoing costs of an ETF, expressed as a percentage of the fund’s assets. Lower expense ratios can lead to better long-term returns.
• Tracking error: For index ETFs, it’s essential to evaluate how closely the ETF tracks its underlying index. Lower tracking error is generally preferable.
• Trading volume: Higher trading volume typically indicates better liquidity, which can result in tighter bid-ask spreads and lower trading costs.
• Fund assets: Larger ETFs tend to have better liquidity, lower tracking error, and potentially lower expense ratios due to economies of scale.
• Index construction: Understand the methodology behind the index the ETF tracks to ensure alignment with your investment goals and risk tolerance.
• Fund manager track record: Evaluate the experience, expertise, and historical performance of the management team. A strong track record can indicate better ETF management and potentially more consistent performance. (Eg: CSOP, LionGlobal, PhillipCapital, and more)

Getting Started with ETFs on POEMS

To begin, navigate POEMS ETF Screener

Here, you can compare various criteria by clicking through different tabs such as:

• Key indicator
• General information
• Pricing
• Classification
• Performance
• Fundamental
• Risk

For a practical example, if you’re looking to explore a fund that tracks the S&P 500, simply tap on the ETF name “VOO”.

This allows you to toggle around and view details like portfolio constituents, dividends, performance, and more.

Usage of ETFs

Investors utilise ETFs for various purposes:

• Portfolio building via core & satellite ETFs
• Dollar cost averaging investing
• Tactical investing into specific investments themes such as Mag7 (MAGS), Nasdaq Covered Call (QYLD), Uranium (URA), etc.
• Hedging via leveraged and inverse ETFs

Dollar-Cost Averaging (DCA)

One of the most prudent and time-tested strategies is Dollar-Cost Averaging.

This involves investing a fixed amount regularly to mitigate the effects of market volatility.

On POEMS, you can do so via 2 ways; Share Builders Plan (and/or) Recurring Plan.

Depending on your individual needs and circumstances, you can choose the option that best suits you.

What to invest on a regular basis?

Consider these themes for your next investment:

• Asset types: Equity, Fixed Income, REITs, Commodity, etc.
• Geographical: Singapore, US, Hongkong, China, Asia, Emerging Market, etc.
• Sector: Technology, healthcare, consumer discretionary, energy, etc.

Conclusion

As we conclude this introduction to ETFs, it is evident that these versatile investment vehicles offer a wealth of opportunities for investors with diverse purposes and interests.

ETFs provide access to a wide range of themes, from broad-based equity indexes like the STI and S&P 500 to thematic investments focused on specific regions or sectors, and even alternative asset classes such as gold, natural gas, bitcoins and more.

As you progress in your ETF journey, consider exploring various ETF themes, understand how to construct a diversified portfolio, and learn about the distinctions between active and passive ETFs. With their cost-effectiveness, transparency, and flexibility, ETFs have become indispensable tools for both novice and seasoned investors alike. Stay tuned for our upcoming intermediate and advanced ETF articles, where we’ll dive deeper into these fascinating aspects of ETF investing.

Your next steps: save these useful tools under your investment arsenal.

• ETF Screener
• P3 Community App
• ETF Market Journal
• Investment Webinar/Seminar