What makes a good ETF?

[robert]

Have you already got investments? In particular, have you chosen to invest in ETFs rather than shares?

If so, the community would benefit from your help.

As a matter of interest for those who are still unfamiliar with ETFs (1) and investment in general, how might you answer the question:

What makes a good ETF?

Are there things you look for in particular before you invest, or select between options?

Is it past returns (we all know these are not necessarily an indication of future performance, and we’re reminded of this each time they’re published)?

Is it something else? Like the theme, the markets or countries that it covers, the assets under management, or maybe the investment provider that created it?

I’m curious if there are issues that you find relevant to talk about beyond the rather coarse ‘return’ (as interesting as this is).

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(1) The definition of an ETF, taken from our Investment Glossary:

An ETF is a type of investment fund.

ETFs can be made up of three main types: bonds, cash and equity. A single asset ETF is just one of the above. A Multi-asset ETF combines a few assets together.

ETFs follow a chosen index, such as the FTSE 100, and are traded throughout the day just like the stock market.

ETF investors aren’t responsible for buying or selling on the market exchange. All they decide is which ETF they want to invest in and when they want to sell it, the rest is up to the Investment Manager or the Investment Fund provider.

[oupabota]

Pretty much all I look for to consider an investment is a well diversified, low cost tracker and since I’m young will lean heavily on equities to maximise return.

[dan_g]

Agree.

From a small selection like Dozens offer, what I want is a few good value, multi-asset ETFs at different risk/cost levels.

Offering enough funds so I can make my own diverse asset choices seems a way off, and complicated for new investors. The minimum per fund investment also drives things in the multi-asset direction as you’d need to invest a lot to have a diverse portfolio in discreet asset type funds…

Transparent costs and ethical investment policy also important.

[robert]

@oupabota

a well diversified, low cost tracker

great, thanks

by definition, most ETFs will be diversified - so do you have a sense of what extra reassurance you would need? Would it help if there was an indication of exactly how many assets were included? Would it be better if you could see this was, say 107 rather than 27?

Do you have a sense of what low-cost means to you?

@dan_g

what I want is a few good value, multi-asset ETFs at different risk/cost levels.

ah, you should hear about this great service I found … called Invest

Would you still want to invest in a ‘portfolio’ of ETFs at different risk levels for yourself, even if you had options at any one given ‘risk level’ for you? For example, would you be looking to have some investments in risk-level 3, 4 and 5 even though your personal risk-rating was 4?

In our case, we exclude the option of risk-level 5 because it can be volatile and therefore go beyond an investor’s ‘appetite’ for risk if they have been rated at 4. Whilst it makes some sense to balance your risks, that is also exactly what an ETF rated at 4 already does for you.

I’m interested in the answers because it helps me understand what information you might be looking to read before committing to investments, and I want to make the process as clear and helpful as possible.

[oupabota]

My knowledge of investing leads me to believe in not putting all eggs in one basket. I don’t have a crystal ball so I have no ideia which sectors are going to be top performers. Therefore I think I’m better off investing in a product that allows me to stake some money in big sized companies, a bit in mid cap and a little in smaller firms.
Also being exposed to the developed world and emerging markets is of great importance as like I said there’s no way for me to know where the biggest returns are going to come from.
In a nutshell that’s my definition of being “well diversified”.
About low costs, my strategy allows me to pick a passive index (or ETF) and choose the cheapest platform with the cheapest fund I can find for the type of assets I want to invest.
Looking at Dozens offering the only fund that could fit me would be the world equities one but that lacks small cap and EM which means it’s not quite there unfortunately but fingers crossed a fund like I want will be added in the future.

[dan_g]

@robert

Would you still want to invest in a ‘portfolio’ of ETFs at different risk levels for yourself, even if you had options at any one given ‘risk level’ for you? For example, would you be looking to have some investments in risk-level 3, 4 and 5 even though your personal risk-rating was 4?

I’m overlapping risk and diversity a bit here I guess.

If I put everything in risk-rating X, I’d still rather spread it between a few funds because of the risk of another Neil Woodford situation…

But I’m more likely to have a few investments at different risk levels. You can argue that 50% at risk-level 2 and 50% at risk-level 4 is really just 100% at risk-level 3. But it is at least partly psychological as it helps me quantify £x is safer - in case I need to replace the car for example and have a smaller amount at higher risk, and ‘actively manage’ this (ie buy low, sell high :)).

Since I like to think I have some financial savvy, I want to be able to have some control - but picking from 1000’s of similar funds is hard and probably yield very little difference unless you really know what you’re doing / watch your funds and the market 24/7.

So I guess I’m asking Dozens to curate me some good (ethical, good value) funds, and let me feel like I’m still being some sort of financial mastermind

[Roman]

Hi robert,

I think there’s some misconceptions and misunderstandings of risk and diversification here. Let me explain…

by definition, most ETFs will be diversified

This is not entirely true, it depends how you look at it. Is a Japaneses small cap ETF diversified? It might provide the exposure to hundreds of individual Japaneses small cap stocks, but the ETF alone isn’t a diversified investment. That’s because it has high geographic risk, geopolitical risk, liquidity risk, currency risk (for an UK investor), etc. comparing to a global equity ETF.

In my opinion, a true diversified investment should diversify in many different ways. This includes asset classes (stock, bond, commodity, etc.), geographic locations, sectors (energy, banking, tech, etc.), company sizes (mega, large, mid, etc.), credit ratings, maturity (1, 10, 15 year, etc.), and many more.

Would it help if there was an indication of exactly how many assets were included?

This is another common misconception. Having more assets in a portfolio doesn’t always make the portfolio more diversified. In fact, the number of assets doesn’t matter that much once it reaches certain level. It’s the unique properties of each asset and the weight of them in a portfolio ultimately matters. For an example, an ETF of 500 large companies in different sectors and countries is more diversified than an ETF consisting of 1000 oil and gas companies in the middle east, even the later one has many more assets in it.

Would you still want to invest in a ‘portfolio’ of ETFs at different risk levels for yourself, even if you had options at any one given ‘risk level’ for you? For example, would you be looking to have some investments in risk-level 3, 4 and 5 even though your personal risk-rating was 4?

The modern portfolio theory says, combining a risk 5 asset and a risk 4 asset can result in a portfolio with the same returns as the risk 4, but at a risk lower than 4; or a portfolio at the same risk as 4, but returns better than 4.

Remember, at the end, what matters to an investor is the return and volatility of the entire portfolio, not each individual asset in it.

As a side note, what’s low cost? Usually the annual charges in the 4th quartile of all ETFs in the same category is considered as low cost. So a Japanese small cap ETF charging 0.4% p.a. is considered as low cost, but an S&P 500 ETF charging 0.3% p.a. is considered as high cost.

[robert]

@Roman

This is another common misconception. Having more assets in a portfolio doesn’t always make the portfolio more diversified. … It’s the unique properties of each asset and the weight of them in a portfolio ultimately matters.

that is very true and I do understand. Of course, it is for this reason that each ETF also has its own risk rating - bringing together lots of high risk companies doesn’t mean less overall risk.

An interesting alternative here for spreading risk are multi-asset funds that include not just different companies and industries, but also instruments, so you get more variety and also greater diversification. Would that be more relevant in this context?

@Roman

As a side note, what’s low cost?

Ah, good question. All relative I guess, but there is no absolute rate for this. The rate will be “low for comparable ETFs with the same theme and risk level”. The point is that there are a broad range of funds, and some may find a reason to charge more. We are interested in keeping this cost as low as possible in that context and we believe that customers should consider this a benefit for long-term investment.

If you are willing to pay higher costs, you might be looking for more actively managed funds instead, and therefore not find ETFs of interest. On the other hand, if you are looking for someone to help you start investing then this might be a more suitable place to start

Would you agree?

[Gaoler]

@dan_g

what I want is a few good value, multi-asset ETFs at different risk/cost levels

Sounds like Vanguard would work for you

[dan_g]

It certainly does.

[Roman]

@robert

An interesting alternative here for spreading risk are multi-asset funds that include not just different companies and industries, but also instruments, so you get more variety and also greater diversification. Would that be more relevant in this context?

Yes. Multi-asset funds often includes both shares and bonds, and sometimes commodities (such as gold, oil, soy beans, etc.) too. This usually provides a much better diversification than holding 10 or 20 thousands different companies’ shares.

@robert

We are interested in keeping this cost as low as possible in that context and we believe that customers should consider this a benefit for long-term investment.

I totally agree with you. Usually when buying things, you get what you pay for, but in the world of investment funds, the opposite is true. Keeping the cost low is very important for a long term investment.

@robert

If you are willing to pay higher costs, you might be looking for more actively managed funds instead, and therefore not find ETFs of interest. On the other hand, if you are looking for someone to help you start investing then this might be a more suitable place to start

Would you agree?

If we are talking about an experienced investor, I would totally agree with you. But people new to investing usually don’t know what do they need. They don’t necessarily know the difference between an index fund and an actively managed fund, or the difference between an actively managed fund and a personalized portfolio managed by a financial advisor.

[Jack]

@oupabota

Looking at Dozens offering the only fund that could fit me would be the world equities one but that lacks small cap and EM which means it’s not quite there unfortunately but fingers crossed a fund like I want will be added in the future.

I’m really hoping for this too, I’d love to see something like Vanguard’s FTSE Global All Cap Index Fund in Dozens. And if it was all wrapped up in a Dozens ISA it would be absolutely perfect.