Market Commentaries

Exchange-Traded Funds Are an Interesting Way to Invest

a-dividend-focused-international-etf-that-hedges-currency-risks If you are reading this article about exchange-traded funds (ETFs) and their systemic risks on FT.com, it is interesting and worthwhile to refer to some of the advantages and disadvantages of ETFs. As the article mentions, ETFs have gained a lot of popularity over the last few years as a new form of passive investing. There are many categories of ETFs, offering both flexibility and freedom for a passive investor to choose what type of investment to focus on. From popular commodities such as oil and gold to major indices such as the S&P 500 or NASDAQ, ETFs allow any investor to follow the moves without worrying too much about individual stock picking. Major advantages of ETFs:

  1. Buy or sell a wide range of assets at any time on a daily basis
  2. Passive investing: capturing the return of the whole index
  3. Diversification
  4. Innovation: investing in new asset classes, new investing ideas
  5. Offer liquidity
  6. Tax advantages
  7. Lower costs compared to mutual funds
Major disadvantages of ETFs:
  1. Systemic risks
  2. No control over the individual components of the ETF
  3. Not able to outperform the general market, as their return should match the return of the asset class, i.e. S&P 500
  4. Problems for emerging markets due to illiquidity and fast turnover
There are also major differences between Europe and the U.S. as ETFs are more popular in the U.S. and are much more tax-efficient in the U.S. market. Distribution and fragmentation have made ETFs less popular as investing choices in Europe. So, overall, ETFs are a smart and effective way of investing, but they are a passive form of investing, so they are not suitable for stock-pickers. This does not mean that they are only long-term horizon-related investing tools. Oil has made a nice rally during the last week, and an investor in an oil ETF going long would have a nice return in a very short period of time. ETFs are also a great example of financial engineering, offering solutions, innovation, and flexibility to modern investing.