Understanding exactly what you’re investing in
This first point may seem obvious; however, this is a very important consideration. There should always be thorough research conducted before investing in any ETF. There are more than 220 ETFs on the ASX today, and although many of these will seem almost identical, each one has its own intricacies. Therefore, it is essential to understand the intricacies of each ETF and what it does in comparison to the rest.
An example would be understanding the difference between the best-performing biotech ETF and the worst-performing biotech ETF. They may seem almost identical at face value, but one biotech ETF might hold next-gen genomic companies comprising of drug and pharmaceutical biomedicine, while the other might focus on agriculture biotechnology. Both are biotech, but they mean different things to different people, thus these differences will affect market performance.
If it’s too good to be true, it often is!
Marketing through social media and other platforms is a mighty force, and should be taken lightly until you’ve done your own research. Every week, these platforms seem to be promoting a ‘new’ or ‘never done before’ ETF to rule the entire market, with the promise that the fund will outperform the market with extremely low risk. These promises are often never factual and are used as a marketing technique to lure people into purchasing the new ETF. Although there are certainly a lot of great and innovative new ETFs that come into the market, you should always tread carefully with anything that promises the world. Always study the market materials closely to develop full understanding of the underlying index’s strategy.
Understanding ETF management fees
ETFs are often portrayed as low fee investments, which is mostly true in the Australian market. In today’s market, the lowest cost Australian market ETF available has a management fee of 0.07% per annum – that’s $7 for every $10,000 invested. Although this does sound appealing for most investors, just because it is labelled as an ETF does not mean that it comes with low management fees. Some ETFs have managements fees of over 1%. It is important to understand the management fee associated with the ETF at hand, so that you know exactly how much you will be paying per annum in fees.
The size of the ETF
The size of the ETF is an important factor when it comes to determining how safe that investment is from closure. The larger the ETF, the safer it is from being closed down. Since 2015, there have been 19 ETFs that have closed on the Australian market. All of these ETFs closed due to their small size and their inability to grow enough to commercialise. A good rule of thumb is to look for market capitalisation of at least $50 million before investing. Once the fund reaches a market cap of above $50 million, they are reasonably safe from being shut down. However, it is important to understand that this does not guarantee any shortfall of the fund and potential closure in the future; it is merely a guide to follow to present the best opportunity for your investment.
Understand what NAV and INAV is
Net Asset Value or NAV is the net value of an investment company’s total assets minus its total liabilities divided by the number of outstanding shares. The fund’s NAV represents a per-share value of the fund, making it simpler for valuing and transacting the fund shares. Fees and other costs will mean that you won’t get to trade in the market at the exact price, though you can use it as a guide to determine the fair value of the product at the start of the trading day.
NAV assists investors to identify the anchoring point to know whether the market is favorable for purchasing. NAV allows investors to:
Know the exact value per share
Analyse the daily performance of a fund and compare it to others
Identify new investment opportunities
Determine if the investment is overvalued or undervalued in the current market
Indicative Net Asset Value or INAV is a measure of the intraday net asset value of an investment. INAV provides a reference point to investors during the day to assist them in understanding whether the current price of the share or fund is close to the NAV price. INAV is reported approximately every 15 seconds by a calculation agent, and is typically found on the exchange that the investment is trading on.