With over two hundred Exchange Traded Funds (ETFs) listed on the ASX alone, it can be very difficult to pick which one is right for you. This is especially the case when there is more than one ETF covering the same underlying index, or asset.
Not all ETFs were created equal, and so it helps to know how to pick ETFs that may help give you an edge. Regardless, picking a strong ETF is relatively simple, it just pays to consider the below things when making up your mind.
Underlying Index or Asset – The underlying index or asset that the ETF is trying to track is perhaps the most important thing. You want to pick an underlying that you believe will perform well over the life of your intended investment. You should also consider your risk tolerance – as the risk between two different exchange traded funds and their underlying index or asset can vary quite dramatically. Finally, consider your current investments – you may wish to invest in an ETF that is dissimilar or uncorrelated to the current investments that you hold – to benefit from the principles of diversification.
Management Expense Ratio or Expense Ratio (MER) – this ratio is the proportion of a fund that is used by the ETF issuer for management and administration expenses of the fund. Whilst there may only be a slight difference between the MER of two different funds, these differences can lead to significantly different returns over time. Most ETFs have an expense ratio of somewhere between 0.10-1.00%, keep in mind that some exposure (such as emerging markets) are likely to have inherently higher expenses.
Currency Risk – currency risk or exchange rate risk arises when you have assets denominated in a foreign currency. The risk is that the foreign currency has an adverse movement against your own currency, potentially lowering returns or leading to losses. An ASX listed ETF with foreign based assets may be affected by movements in the foreign currency in which it is denominated – so keep this in mind if you are considering an ETF with foreign listed assets or indices.
The ETF issuer – The ETF issuer is the firm that constructs and manages the exchange traded fund. The reality these days is that after accounting for the expense ratio, there is little difference between ETF issuers. However, it may still be worthwhile to pick the largest and most reputable issuers, because they are likely to have the most market makers, offering the highest liquidity or volume, and the tightest bid-ask spread.