Exchange Traded Fund (ETF) Investing
- Philippa Anselmino
- Apr 21, 2020
- 4 min read
Updated: Dec 18, 2020
ETFs may possibly be the best investment invention of the last 100 years as it allows people to invest in a basket of companies that follow certain rules, set out by the ETF. It allows people to invest in select companies without having to actively pick them out, which is why ETF investing is called "passive investing". While it took ETFs a while to take off when they first launched in 1976, passive investing is now so popular that people have started calling it an ETF investment bubble. Something to be aware of.
So what are ETFs?
ETFs can be purchased through your brokerage account in much the same way as you would purchase an individual company's stock. Each ETF has a so-called ISIN number attached to it, which you can simply type into the search bar inside your personal brokerage account. ETFs are issued by various different companies, the most well-known of which are Vanguard and Blackrock. These companies make money from issuing ETFs by charging you a small annual fee (ranging from 0.07% - 0.70% of the invested amount), which also covers the admin of quarterly to annual rebalancing of the companies within the ETF.
The rules that ETFs follow may include tracking prominent indexes such as the S&P 500, NASDAQ or Dow Jones Industrial Average, but can also follow certain themes such as Clean Energy, Electric Vehicles, Cloud Computing and Cybersecurity, or more broadly Information Technology, Healthcare or Emerging Economies. These thematic ETFs tend to be actively managed (rather than passively follow an index) and therefore demand slightly higher annual management fee (~0.40%-0.70%) while the Index tracking ETFs have lower fees (~0.07%-0.33%). Beating the benchmark indexes (i.e. S&P 500, Nasdaq 100) is incredibly hard to do, hence actively managed thematic ETFs that demand higher fees are not always the most rewarding ways to invest. As I will highlight below, there may be some exceptions to this rule in Cathie Wood and Bessemer Venture Partners.
The recent Coronavirus pandemic has possibly revealed some of the limitations of passive investing, especially in indexes that track a wide array of industries (materials, utilities, financials, technology, consumer staples, real estate, energy, etc.), as some are disproportionately affected by the repercussions of an economic lockdown, causing share price performances to substantially diverge in their performance, possibly for years to come. Something to think about when choosing your ETF.
So what ETFs should you buy?
As the best performing market for the last 100+ years, the US stock market has for this reason been one of the most popular investments in the world. There are around 4000 public companies in the United States. These range in size from micro-cap (market capitalisation of under $300 million), to small-cap (market capitalisation of between $300 million - $2 billion), to medium-cap (market capitalisation of $2 billion - $5-10 billion), to large-cap (market capitalisation over $ 10 billion). Definitions vary but these are the broad classifications. The Vanguard Total Stock Index (VTI) ETF tracks the entirety of these ~4000 public US companies. This ETF is not available for purchase in Europe as it require a US brokerage account, which in turn would require US residency, but would be the most diversified in terms of exposure to the American stock market. It tracks the entirety of the US stock market with all its different industries. However, the large-cap companies still make up about 20% of the the VTI ETF and are thus responsible for most of the returns. ETFs that solely track a mix of these large-cap US companies is the S&P 500, which can be easily purchased through your European brokerage account. To whittle these large-cap companies down even further, the NASDAQ 100 ETFs focus on large cap growth companies only, which for that reason tends to be heavily weighted towards information technology companies. Conversely, the Russell 2000 ETFs, which can also be purchased in Europe, focuses on the ~2000 US small- and medium-cap companies. So in that way you can be quite selective with your choice of ETFs and could even vaguely replicate the VTI ETF in a European brokerage account. But it is also possible to focus more heavily on only one specific industry, which you may belief will outperform other industries such as biotech, healthcare and/or information technology, without actually having to pick out the companies involved in those trends yourself, and can have both a global or US-centric focus.
Popular Index ETFs
Index tracking ETFs
Nasdaq 100 Index ETF - Large-Cap Growth (Blend of US and Global Companies) Available in GBP from Blackrock (iShares) on the London Stock Exchange Annual fee: 0.33% of invested capital ISIN: IE00B53SZB19 https://www.morningstar.co.uk/uk/etf/snapshot/snapshot.aspx?id=0P0000SM0C
S&P 500 Index ETF - Large-Cap Blend
Available in GBP from Blackrock (iShares) on the London Stock Exchange
Annual fee: 0.07% of invested capital ISIN: IE00B5BMR087
Russell 2000 ETF - Small/Medium-Cap Blend
Available in GBP from Legal and General on the London Stock Exchange Annual fee: 0.45% of invested capital
ISIN: IE00B3CNHJ55
Thematic ETFs
While the same may not hold true in the future, these thematic actively managed ETFs have so far beaten out the traditional US benchmark indexes.
https://fundcentres.lgim.com/uk/private/fund-centre#Strategy=Thematic (Breakthrough Healthcare ETF)
(Video Gaming and E-Sport ETF).
(Bessemer's Venture Partners' Cloud Computing ETF - a highly respected venture capital firm that actively manages this cloud software ETF).
(Personally, I like the ARK ETFs the most, managed by Cathie Wood and her team, because they invest exclusively in companies at the cutting edge of innovation in different industries. This makes it different to the traditional benchmark indexes like the S&P 500 and even the more innovative Nasdaq 100, which are heavily skewed towards blue-chip and profitable companies,
Unfortunately, the ARK ETFs cannot easily be purchased through a European broker but the ARK Research Centre is nonetheless an excellent resource for ideas on individual companies, especially in terms of following the companies included in the ARK Innovation ETF, ARK Genomic Revolution ETF and the Next Generation Internet ETF). Daily trades can be followed by subscribing here.
For the full array of ETFs, take a look at the following from Blackrock:
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