7 questions to ask before investing in ETFs

Whether you’re new to ETFs or looking for more information, check out our answers to some of the most commonly asked questions about ETFs:

1. What is an ETF?

An ETF (exchange traded fund) is an investment vehicle that holds a diversified portfolio of assets and trades on a stock exchange, allowing investors to buy and sell units throughout the day at market prices.

ETFs can provide exposure to a wide range of strategies and asset classes, including broad market indices, sectors, active approaches, smart beta or factor strategies, thematic investments, and physical assets such as real estate or infrastructure.

Each ETF share represents a proportional interest in the underlying portfolio. Most ETFs are regulated investment vehicles, offering investor protections such as independent oversight and the segregation of fund assets from the provider.

2. What kinds of ETFs are available?

ETFs cover every asset class and almost every global market. With ETFs, investors can also access almost any investment strategy, including:

3. How can I evaluate an ETF’s objective — and risks?

Understanding the objective

An ETF's objective shapes how it invests. Index-based ETFs aim to track a benchmark, and the way that index is constructed — whether weighted by market capitalisation, equally, by yield, or another method — will influence the ETF's characteristics and performance.

Actively managed ETFs, by contrast, generally seek to outperform a benchmark or to deliver a target outcome through selective investment decisions rather than replicating the market.

How the ETF accesses its exposure also matters

Some indexed ETFs hold all the underlying securities in the index (full replication), others hold a representative sample (optimisation), and some use derivatives (synthetic replication). The approach used can affect how closely the ETF tracks its benchmark and the types and levels of risk involved.

Understanding the risks

Like all investments, ETFs carry risk. The primary risks reflect the ETF's investment objective and the assets it holds. Broader risks — such as currency movements, interest rate changes, and economic conditions — also apply.

Two risks worth noting:

• Tracking difference: For index-based ETFs, returns may not perfectly match the index due to costs, sampling, and/or rebalancing.
• Premium / discount to NAV: An ETF's market price can temporarily diverge from the value of its underlying assets due to market sentiment or volatility. In most cases, prices tend to revert toward NAV over time, and these short-term movements are generally less relevant for long-term investors.

4. How do investors use ETFs?

There are a myriad of ways to use ETFs in portfolios. Investors commonly use ETFs to:

• Build diversified portfolios — A single ETF can provide exposure to hundreds or thousands of securities, helping investors spread risk across asset classes, sectors, and geographies.
  
• Pursue long-term compound returns — ETFs suit buy-and-hold strategies, allowing investors to stay invested at low cost over time. For example, reinvesting distributions from an equity ETF can compound returns over a multi-year savings horizon.
  
• Create core-satellite portfolio strategies — Low-cost index ETFs can form the core of a portfolio, while active or thematic ETFs serve as satellites to target specific opportunities. For example, a broad equity index ETF as the core, paired with an active credit ETF for added yield.
  
• Access hard-to-reach markets — ETFs can provide efficient entry into markets that are otherwise difficult or costly to invest in directly. For example, emerging market debt, commodities, or small caps.
  
• Implement regular investment plans — Because ETFs can be purchased in small amounts on exchange, they are well suited to regular saving strategies, where investors contribute at regular intervals.
  
• Manage portfolio risk and concentration — ETFs can help reduce single-security or single-sector risk by broadening exposure. For example, replacing a concentrated portfolio of individual stocks with a diversified equity ETF.

5. What are the costs associated with ETFs?

While the list below may not be comprehensive, it does discuss the majority of associated expenses when investing in ETFs.

6. How do you measure ETF performance?

While past performance is not an indication of how an ETF may perform in the future, investors may wish to evaluate an ETF’s performance against its stated objective or benchmark.

• For an index-based ETF, performance is measured against its benchmark by the ETF’s tracking difference (which shows how closely it has been able to replicate the benchmark).
• For an actively managed ETF, an investor might look at how the ETF has performed, based on the outperformance objective and the benchmark.
  

Tracking difference is the extent to which the ETF’s return deviates from the return of its benchmark index. Several factors can influence how closely an ETF follows its index, including:

• The replication method used (full replication vs sampling)
• The ETF's operating costs
• How the manager handles index rebalancing and corporate actions

Tracking error measures the consistency of the tracking difference over time, expressed as a standard deviation. A low tracking error means the ETF's returns have closely and reliably tracked the index, while a higher figure suggests more variability in how the ETF tracks its benchmark.

7. How do investors buy and sell ETFs? And why is liquidity important?

Many investors buy and sell ETFs on the stock exchange through a brokerage account, just like trading shares. There are two common order types:

• Market Orders. A market order executes immediately at the best available price based on current supply and demand. While execution is typically fast, the final price is not guaranteed — it may differ from the last-traded price, particularly in volatile conditions.
• Limit Orders. A limit order sets a maximum purchase price or minimum sale price. The trade will only execute at that price or better. While this gives investors greater control over pricing, execution is not guaranteed — the market price must reach the specified level with sufficient volume to fill the order.

Why liquidity matters

Liquidity refers to how easily ETF shares can be bought or sold without significantly affecting the price.

ETF liquidity has two layers:

• On-exchange liquidity — the trading volume of the ETF itself
• Underlying liquidity — the liquidity of the securities the ETF holds

An ETF with lower trading volumes can still be highly liquid if its underlying holdings are liquid. ETFs with strong liquidity on both levels tend to have tighter bid/ask spreads, reducing trading costs for investors.