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Exchange Traded Fund

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How I choose them

Hello, my friends! Today I will write in more detail about ETF – Exchange Traded Funds. I have mention this (directly or indirectly) in previous posts. You can see here.
Today I will try to explain how I choose an ETF, and at the same time, write about the characteristics that I believe it’s important to pay attention.
Every ETF should have a fact sheet. See here an example of a fact sheet for more information about, the “iShares Core S&P 500 UCITS ETF USD (ACC)”.
Disclosure: I don’t use this one, it’s only an example.

Definition

An ETF is a fund that is listed on a stock market. It has shares that you can buy or sell, multiple times (even in the same day). Just like any other share of a company.
It only tracks an index, i.e., it means that it is not actively managed (There are ETF actively managed, but I will not consider this for now…).
The fact that it isn’t actively managed, is the main reason why it fits so perfectly in a Passive Investing strategy.

So looking to the PDF/Factsheet of an ETF, this is what helps me to choose.

Asset Class

Here is where I look for the type of asset I want to track. Whether it is equity/stocks or bonds, or any other type.

Fund Base Currency

This is important if I want to choose an ETF that works in a specific currency. This one is in USD (US Dollars).

Trading Currency

You can have a fund in USD, but that you can buy shares for example in EURO (EUR) or Pounds (GBP). This could be useful if your broker/bank has fees for changing the currency. I can buy shares in EUR (even if the fund is in USD) and save money in fees. If I have that trading currency available.

Attention: this will not protect me from currency (USD/EUR) changes. For that, I would need an ETF that hedges USD currency in the fund back to EUR. It will probably cost me more.

Benchmark

S&P500 is probably the most important index out there. And it’s used as benchmark for the ETF.

The full name is Standard & Poor’s 500 Index. It’s a market value weighted index, i.e., the first positions of the index will be occupied by the most valuable companies in the US (companies that are traded in stock markets). Right know the most valuable one is Apple Inc. so naturally, it occupies the first position in the index.

If I invest money on this fund, part of my money will be used to buy shares of Apple. In this example, if you look to the pdf/factsheet, you’ll see that Apple is 3.57% of the ETF. It means that 3.57% of the money invested in this fund is in Apple shares.

ISIN

This is the “International Securities Identification Number”, i.e., is a unique number that identifies the fund.

Total Expense Ratio

Here we can find the fee to manage the ETF. In this case is 0,07%/year. So every 1000$ invested will have a fee of 0,70$ (less than 1$). As you can see is a lot cheaper than actively managed funds out there. If I have similar ETF options, I normally choose the cheapest one.

Methodology

Normally you have two types of replications: Physical and Synthetic.

Physical means that the fund is actually buying and holding the shares of companies from the index that is trying to replicate.
Synthetic ETF uses swap contracts, where it enters into an agreement with other counterparties – like investment banks – that then promises to pay the return to the fund. So it doesn’t hold shares of companies as the physical replication.
I will write in more detail about this in the future. Personally, I prefer a physical replication ETF if I have that option. A Full physical replication.

Use of Income

We have two options here: Accumulating and Distributing. Accumulating basically reinvest the dividends of companies in the ETF automatically. Distributing does what the name says, it distributes a dividend periodically.

I always look for the accumulating option, because I believe is more efficient. Thus more simple.

Net Assets of Fund

Sometimes referred as Assets under Management (AuM), it’s basically all the money that is being managed by the fund. An ETF with a small AuM means that there is a possibility that it will be closed in the future. In a Passive Investing strategy, the concept is to invest for years, maybe decades, so I don’t want to have an ETF that may close because it has a small AuM.

Normally I look for a fund with at least 100 million euros/dollars of AuM.

Ticker

The “Ticker” is different from the ISIN (that we have talked previously). Here we have some letters (sometimes numbers) that identify an ETF on an exchange. For the “iShares Core S&P 500 UCITS ETF” you have a unique ISIN, but multiple tickers. In the London Stock Exchange (in USD) you have the ticker ‘CSPX’, but the same ETF in GBP is ‘CSP1’. For XETRA or Stuttgart Stock Exchange (EUR) it has the ticker ‘SXR8’.

This is important because if you want to trade on a specific exchange, with a specific trade currency (USD, GBP or EUR), you need to know the ticker.

 

So here we have some of the characteristics that I look for when analyzing an ETF. What about you?

If you agree/disagree, or wish to add something to this thoughts, please feel free to comment.
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Nothing on this site should ever be considered to be advice, research or an invitation to invest. Please read the disclaimer.

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8 Comments on "Exchange Traded Fund"

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Dav7
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To much info, need to read this more carefully! But how do you buy your ETF? You go to the bank or use some website?

FInvestor
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Good information!
What are your toughts regarding diversity?
Would it be achieved it with a portfolio with 2 ETF?

Best regards,

Chee Yang
Guest

Awesome post on ETFs. I had personally bought an index fund myself. Do you know if it is possible for foreigner to buy ETFs directly through the ETF provider (blackrock, vanguard) without having a broking account?
Great site by the way. Definitely following it.
Cheers,
Chee Yang

Vdr
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Hello João,

How do you backtest & correlate your ETF Portfolio ? Includes European ETF or just US ETF?

Thanks for sharing.

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