Picking an ETF (exchange traded fund):

Once you have chosen the index or sector you wish to track you may wish to consider the following as part of your decision making process.

  • Quality of the issuer. The events of 2008 forced one, perhaps for the first time, to consider the relative strength of financial institutions.

    • What precisely are you buying. Some issuers actually hold underlying shares that make up the index. Others may use derivatives, such as swaps, options etc to mimic the performance of the index. In this latter case there is no parcel of actual shares corresponding to the shares in the ETF that you buy

    • Who is the custodian? The ETF issuer may have parked actual securities or other qualifying investments with a custodian. 2008 reminded all of the possible risk posed by the choice of custodian

    • Where used, financial instruments such as Swaps will involve some counterparty risk

  • Size of the Fund. This can be related to the fund's liquidity which will affect how quickly your buy or sell order is executed, and therefore the proximity of the price you get to that when you issued the order. Obviously this is most important in fast moving markets.

  • The TER (Total Expense Ratio), not just the management fee. It is obvious that higher costs will both reduce both your overall return and the ability of the fund to track an underlying index

  • Buy/Sell spread. A fund might choose to support a lower advertised TER by charging a larger spread. A larger spread will also reduce potential returns.

  • The historic tracking error. Some funds seem to track more closely the underlying index than others.



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