George Osborne gives investors yet another reason to like ETFs

Managers of UK-domiciled exchange traded funds (ETFs) will no longer have to pay stamp duty when they buy shares for their funds, George Osborne revealed today.

The move is designed to encourage more ETFs to come to London and to be ‘domiciled’ in the UK. ETFs domiciled in, say, Luxembourg already avoid stamp duty on their purchases.

But now, from April, no ETF will have to pay stamp duty on share purchases. And that gives them a significant cost advantage over other forms of investment fund such as your traditional unit trusts.

As a result, we may see cuts in charges for some ETFs – which is good news, given that they’re pretty cheap already.

It’s also likely to encourage the launch of more ‘actively-managed’ ETFs, or ones with more sophisticated strategies such as ‘smart beta’ ETFs. Up until now, the majority of ETFs have been passive funds where the manager attempts to replicate the performance of a particular stock market index – for example, the FTSE All-Share.

But we have seen the emergence of some ‘active ETFs’ in the last couple of years where the fund manager has some input into the choice of investments. And given that active funds tend to ‘churn’ their investments more frequently than passive funds, there is greater potential for active ETFs to undercut the charges levied by other actively managed funds.

Today’s move is sensible, although I’d be much happier if stamp duty for share purchases was abolished completely.

A small note on synthetic versus physical ETFs

If you do decide to buy an ETF, it’s best to invest in a ‘physical’ ETF that actually owns the underlying shares in the fund or the underlying bonds or commodities.

Some ETFs are ‘synthetic’ and attempt to replicate an index by purchasing derivatives. Most of the time, this isn’t a problem, and synthetic ETFs often manage to track an index more accurately than a physical fund.

However, with a synthetic ETF, you are exposed to counterparty risk (in other words, the small danger that the party providing the derivative goes bust). If that’s the case, synthetic ETFs still own collateral to underpin their value, but the risk is that in a panicky market, this collateral may not reflect the full face value of the ETF itself.

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