Exchange traded funds, or ETFs, operate as a sort of cross between unit trusts and investment trusts.
Closed-ended like an investment trust
From the perspective of the person buying into the fund, ETFs are closed-ended, like investment trusts: once the required level of investment has been met, that’s it and no further units are available for purchase. This allows ETFs to avoid the hassle of creating further units and cashing units in, which means much lower administrative costs than, say, an OEIC.
Of course, you can still buy and sell units in an ETF, but you will need to find a broker to action this for you. You can invest in ETFs via an ISA -- this is a good way to protect any gains from taxation – but you will need to do it through a self-select ISA, and via a broker.
Open-ended like a unit trust
Larger financial institutions like banks look at ETFs from the other side: to them, ETFs are open-ended. this means that even if the ETF has reached its investment threshold (or at least the one that applies to you) and is turning away individual investors, it may choose to accept an investment from a bank, and would thus issue new ETFs for them.
The other side of this policy is that ETF managers will ‘buy back’ larger volumes of ETFs from individual investors like yourself. This means that ultimately, ETFs don’t stray too far from the value of their assets.
ETFs available in the UK
There’s now a whole range of ETFs available to private investors. Many are operated by iShares and the best known is the iShares FTSE 100 which tracks the FTSE 100 index. Just like a conventional index tracker, this ETF aims to follow the FTSE 100 index as closely as possible.
The strange thing about past performance and ETFs
One of the big debates in investing is whether past performance can be accepted as a sound indication of future performance -- so whether the fund that had five great years is necessarily a better buy than the fund that had five forgettable years. Research shows us that this isn’t the case: strong-performing periods can easily be followed by less awesome periods, so a fund’s past performance should not be taken as an indication of how it will perform in the future.
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