An exchange traded fund (ETF) is an investment fund that holds a basket of securities, such as stocks, bonds, or commodities, and tracks an index. ETFs trade on an exchange and can be bought and sold throughout the day at prices that change according to the underlying index.
Whether you’re new to investing or a seasoned pro, exchange-traded funds can be a valuable addition to your portfolio. They offer a simple, efficient way to invest in a broad range of markets and asset classes. If you’re looking for a cost-effective, convenient way to invest, ETFs may be the right choice for you.
What Are ETFs and How Do They Work?
Exchange-traded funds offer investors the attributes of assets such as stocks, bonds, or foreign currency. ETFs track the performance of a certain index such as the NSE 20, NSE 25, S&P 500, and Dow Jones. They can either be domestic or offshore.
ETFs hold multiple underlying assets, and they are a good choice for those who are looking to diversify. They can contain stocks, bonds, and other investment types. ETFs can hold various stocks from different industries or stocks from one industry or sector. For example, a bank-focused ETF contains stocks from various banks.
Most ETFs are open-ended, meaning they don’t limit the number of investors. In Kenya, ETFs are regulated by the capital market authority.
Types Of Exchange-Traded Funds
ETFs are either passive or active ETFs. Here is a summary of each.
Passive ETF’s
Passive ETFs attempt to replicate the performance of a broader index, which can be diversified like the S& P 500 or focused on a specific sector or trend. An example of a passive ETF is a fund that focuses on mining companies.
Active ETFs don’t target particular indexes; rather, portfolio managers decide which securities to include in the portfolio. They tend to be more expensive than passive ETFs but have more benefits. Below are some actively managed ETFs.
Bond ETFs
They invest in various bonds, and they give investors regular income. They may include government bonds and corporate bonds. They don’t have a maturity date and trade at a premium or discount.
Commodity ETFs
Commodity ETFs invest in commodities such as precious metals and crude oils, among others. They are good options during a stock market slump. Plus, they provide a cheaper option for owning commodities.
Stock ETFs
Stock ETFs contain a basket of stocks to track a particular industry or sector. The main aim of such ETFs is to allow the investor to diversify their funds. Stock ETFs charge lower fees, and you don’t have to own the stocks.
Currency ETFs
Currency ETFs track the performance of currency pairs and consist of domestic and foreign currencies. They are mostly used to track the performance of currencies during political and economic developments and hedge against volatility in forex markets. Some are also used to hedge against inflation.
Inverse ETFs
By shorting stocks, inverse ETFs attempt to profit during periods of the stock decline. Shorting involves selling a stock when expecting a decline and buying it at a lower value.
Industry/Sector ETFs
These are funds that focus on a specific industry or sector. For example, an energy sector ETF will include companies operating in the energy sector.
How To Buy ETFs
An exchange-traded fund is an investment fund traded on stock exchanges, like stocks. It holds assets such as stocks, commodities, or bonds, and trades close to its net asset value over the trading day. ETF prices fluctuate throughout the day as trading occurs.
ETFs are a type of security that provides exposure to a specific asset or group of assets without requiring the purchase of the underlying assets. For example, the NSE 25 ETF provides exposure to the 25 largest companies in Kenya by market capitalization that are listed on the NSE.
ETFs can be bought and sold through a broker that offers access to the stock market. They provide investors with a convenient way to get exposure to a specific asset class or group of assets without the need to individually select and purchase the underlying securities.
Advantages Of Exchange Traded Funds
Exchange-traded funds (ETFs) are one of the most popular investment vehicles for a variety of reasons. Here are some of the main reasons.
Low investment costs
ETFs are passively managed, and they have a lower expense ratio. The operating expenses for trading ETFs tend to be lower as compared to mutual funds, which are actively managed.
Diversification
When you invest in ETFs, you can diversify your portfolio without selecting a particular bond or stock. They allow you to invest in niches where it may be difficult to invest in specific stocks or bonds.
Flexibility
ETFs allow you to move your money between bonds, stocks, and commodities. You can target specific market segments or even individual stocks.
Exposure to foreign markets
ETFs are also a great way to get exposure to foreign markets.
Transparency
Most ETFs disclose their earnings daily, monthly, or quarterly, with a bit of lag.
Tax-exempt
ETFs are exempt from capital gains in Kenya. Once you sell the ETF, you will be exempt from capital gains tax.
Accessibility
You don’t need a lot of money to invest in ETFs. You can grow your portfolio as you go.
Liquidity
It’s easier to liquidate an ETF as compared to real estate. Consider investing in an ETF if you will need your money urgently.
Disadvantages Of Exchange Traded Funds
While ETFs have several benefits, they also have some drawbacks. Here are the main disadvantages.
Less diversification for foreign ETFs
If you choose to invest in foreign stocks, you may be limited to large caps due to the few groups of equities available in the market.
Lower dividend yield
Dividend-paying ETFs may not earn the same dividend as owning the actual stock. The risk of owning an ETF is lower as compared to owning actual stock but you will earn a lower dividend.
The costs of investing in ETFs could be higher.
When you invest in an ETF, you will need to pay commissions and management fees. If you compare investing in ETFs to other funds, they could be less expensive. But compared to investing in stocks, the cost of investing in ETFs could be higher. You don’t pay management fees when you invest in stock.
ETF Investing 101
You can buy ETFs on the stock market. To buy the ETF, follow the below steps.
Apply to buy the ETF through the broker.
The broker will then give you a reference. For example, if the ETF is tracking the NSE 25 Share Index, the broker will deliver shares of the NSE 25 companies according to their weighting in the index or based on the cash value of the share.
ETFs In Kenya
ETF trading is not a very old concept in Kenya. You can buy exchange-traded funds on the Nairobi stock exchange or the New York stock exchange. Banks such as Standard Chartered offer EFTs from the New York Stock Exchange. Below is the available ETF for Kenya.
ABSA Gold-backed Fund.
The gold-backed ETF is sold similarly as shares. The price of the share is based on the prevailing market price of gold in USD. Each gold security is equal to 1/100th ounce of gold. This is held in a secure depository and backed by physical gold.
To buy the ABSA gold-backed backed you need to buy a minimum of 100 shares, which is equivalent to one ounce of gold. As of December 2022, the price of one share was Ksh 2,140. You can only buy additional shares in increments of 100 units.
In a nutshell, ETFs are managed funds that contain many other different investments. ETFs are traded on the open market and can be bought and sold like stocks, so the price fluctuates during buying and selling times, and you can try to time the movements for a good entry or exit point. However, ETFs often trade at a similar price to the “net” value of their constituent mix, making them popular with long-term investors who aren’t looking for huge swings in returns.