Exchange Traded Funds

I have just returned from America, where there seems to be a new form of investing that is capturing the imagination - Exchange Traded Funds. Can you please explain how these work. My understanding is that you invest in a stock market index as opposed to an individual company share, thereby reducing your risk.

Exchange Traded Funds (ETFs) are index-tracking funds covering major stock market indices such as the FTSE 100 and S&P 500. They can also cover a range of more specialist sectors such as cyclicals, energy, pharmaceuticals and telecoms. They can be used as a core equity holding, to target a specialist style or sector, to provide international diversification or portfolio hedging, because they can be borrowed and sold short.

They are a mixture of unit trusts and investment trusts. The difference is that they are traded in real time like stocks and shares. Unlike unit trusts, which are priced once daily, ETFs are priced throughout the day like exchange-traded shares. You can buy and sell an index at the prevailing price during normal trading hours, making them a highly liquid investment.

Tax-wise, ETFs are treated the same as individual company shares. For example, buying an ETF on the London Stock Exchange will not incur any income tax because these funds do not capture any dividend yield. You also avoid stamp duty. As a non-UK resident you are not subject to capital gains tax, unless you repatriate the proceeds. You must of course always consider any local tax implications in Malta.

Charges on ETFs are very competitive. The total expense ratio on the average ETF is just 0.53% (source: Ffitzrovia International). This compares to 0.97% on the average unit trust tracker.

Their popularity is increasing at an incredible pace. This year, 55 new ETFs have been launched worldwide with total assets under management increasing by $19.5 billion to $124.2 billion. There are now 257 ETFs globally. Compared to other equity-linked investments, ETFs are clearly growing in popularity, particularly in the US. It won't be long before this new way of investing becomes equally as popular in Europe.

(Source: Investment International)

Please address any financial questions to: Mark Hollingsworth, c/o The Sunday Times, PO Box 328, Valletta CMR 01. Alternatively he can be contacted on 2131-1121/9984-2614 (office hours).

Past performance is no guide to the future and except where amounts are guaranteed the price of your investments (and the currency in which it is denominated) may fall as well as rise. Malta Exchange Control Regulations must be observed. Your personal tax situation will depend upon residence, always consult a professional adviser. This article does not intend to give investment advice and the contents therein should not be construed as such. Readers are encouraged to seek professional advice regarding their personal financial situation.