Be prepared to make the most of ETFs

There are potential pitfalls with exchange-traded funds (ETFs), as with any other investment product – but by making sure you know what you're buying, you can avoid them. Paul Amery explains.

Exchange-traded funds (ETFs) are under attack. In mid-April the global financial system's top three regulators (the G20 Financial Stability Board, the International Monetary Fund (IMF) and the Bank for International Settlements) all spoke out about what they see as a dangerous trend towards rising complexity in the ETF market, potential conflicts of interest in the way ETF ranges are operated, and the systemic risks that ETFs might pose to the broader financial market.

Let's address these concerns in turn. The argument that ETFs are becoming too complex is not new. From their beginnings as tradeable tracker funds, based on a few well-known benchmarks, ETFs have moved to cover a very broad range of asset classes: commodity futures, equity index volatility, credit default swaps you get the idea. The solution is easy as we've pointed out in the past: understand what you're investing in. Before you buy an ETF, look at how the underlying benchmark is put together, how its weightings are determined and, most importantly, what costs might arise from the way it is built. It makes no sense to switch to a notionally cheaper tracker, only to pay out multiples of your fee savings on hidden index costs.

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Paul Amery

Paul is a multi-award-winning journalist, currently an editor at New Money Review. He has contributed an array of money titles such as MoneyWeek, Financial Times, Financial News, The Times, Investment and Thomson Reuters. Paul is certified in investment management by CFA UK and he can speak more than five languages including English, French, Russian and Ukrainian. On MoneyWeek, Paul writes about funds such as ETFs and the stock market.