Exchange-traded funds (ETFs) are a cheap and efficient way of gaining access to a specific part of the investment world.
Listed on exchanges, just like shares, they allow investors to own a basket of shares or bonds that own a certain theme or market.
While they initially tracked mainstream market indices, such as the FTSE 100 or S&P 500, now ETFs are used to get exposure to a wide range of niche investment ideas.
First common in America, their popularity is exploding in Britain too. Figures from the London Stock Exchange Group show that £2.7 billion is invested in ETFs launched in 2023, and over the past 12 months new ETFs have attracted £5 billion worth of investments. This comes even as the market for new investment products goes through a downturn.
The stock exchange said: “With half the year gone, we’ve seen slightly more than a third of the funds launched when compared to all of 2022 — although the pace has picked up a touch over the past month.”
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It says this is because tighter monetary policies have meant that that seed money, needed by all ETF promoters, has started to evaporate as interest rates increased.
“Investment banks are making more on cash, which has somewhat suppressed their animal spirits, in that they do not need to take so many risks to get a significant yield back on their cash, so are less likely to use it for ventures such as new fund launches. Conversely, it has become more expensive for companies to borrow cash to use as seed money. The result is this more subdued new product launch environment.”
However, there have been some recent ETF launches that caught our eye, as well as some that might be best avoided.
ETFs to consider
The most popular new ETF launch is the iShares UK Gilts 0-5yr ETF GBP Acc (LSE:IGL5). Only listed in London in May 2023, it already has more than £1 billion in assets.
The ETF buys UK government bonds that are maturing in under five years, which are considered “short duration” bonds.
These appeal to investors at the moment because short bonds actually yield more than longer bonds as a results of expectations that interest rates will rise in the short term but come down in the medium term, but also because shorter bonds are less sensitive to interest rate changes and so have performed relatively well as interest rates have risen over the past two years.
Income payments are reinvested, meaning that for investors looking to collect an income from government bonds, the iShares UK Gilts 0-5yr UCITS ETF GBP (dist) is more suitable as it pays out annual income received.
Launched in August 2022, together both ETFs have more than £450 million invested. They cost 0.22% a year in fees.
An equal weight ETF owns the same amount of every stock in an index. So, instead of having about 7% invested in Apple Inc (NASDAQ:AAPL), this ETF has just under 0.25% invested there. This means that it can be considered a more value-oriented investment approach, as it is not concentrated in the biggest shares, which are currently among the most expensive relative to earnings. Its price-to-earnings ratio is about 18, compared with 22.5 for the regular index.
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This ETF could therefore be attractive to investors who want to own US shares but are concerned about investing too much in technology shares.
Another ETF that caught our eye was the VanEck Defense UCITS ETF ETF. The ETF owns 29 companies involved in defence technology, large-scale cybersecurity, and defence-relevant service providers.
Launched in March 2023, there are versions priced in both pounds and dollars. It costs 0.55%.
The ETF group said: “As global uncertainty persists, the issue of security and defence has once again become a top concern for financial investors.”
Investing in thematic ETFs after they launch is normally an unsuccessful strategy, as we explained here, but this ETF is off to a strong start, returning 10% in sterling this year.
Its holdings have a price-to-earnings ratio of 20.4, which is about the same as the MSCI World index, meaning that you are not paying a premium for shares owned by this ETF.
For investors worried about conflict, such as an escalation in the Ukraine/Russia war or an invasion of Taiwan by China, this ETF would likely perform well if stock markets were falling as a result of geopolitical tension. It could be considered similar to holding some gold in a portfolio.
ETFs to avoid
Peter Sleep, senior investment manager at fund group 7IM, says that the Buffettique Growth ETP (LSE:BUFF) was one to avoid.
The ETF buys other ETFs, stocks and funds that relate to Warren Buffett’s investment career, going back to his early days’ focus on small-caps to his present day’s investment in quality companies at fair prices. It invests 80% in a core portfolio of funds and the rest in a small portfolio of “Buffett-like” companies.
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The portfolio includes some popular investment trusts, such as BlackRock Smaller Companies (LSE:BRSC) and Scottish Mortgage Ord (LSE:SMT), as well a security that attempts to deliver twice the return of Warren Buffett’s Berkshire Hathaway Inc Class B (NYSE:BRK.B). It has risen 7.11% since launch in spring this year.
But Sleep is not a fan. He said: “The ETF had very little to do with Buffett’s type of holdings and committed the cardinal error of having a long-term position in a daily levered investment.”
Nor does Sleep like the Global X s&p 500® Covered Call ETF-Inc GBP (LSE:XYLP).
“The way it works is by buying the S&P 500 index and selling call options on the underlying shares. By selling calls you surrender some of your capital gain in return for boosting your income. For UK taxpayers this is a disastrous combination because it turns your capital gain taxed at 20% into income taxed at 45%,” he said.
ETFs on the Super 60
There are a number of ETFs on our Super 60 investment ideas list. They include the iShares Physical Gold ETC GBP, iShares Core MSCI World ETF USD Acc GBP (LSE:SWDA), and the WisdomTree Enhanced Commodity ETF (LSE:WCOB).
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