ETFs, or Exchange-Traded Funds, are a wise investment right now, as they are safer than investing in regular stocks, yet just as flexible. With many new people getting into them, questions like “do ETFs have earning reports?” and “how do I select the right ETF to invest in?” are getting more common.
Like all funds, ETFs are required to release quarterly earnings reports. The 8 things to look for in ETFs include:
- Underlying index or assets.
- Differences in the tracking system.
- Minimum asset level.
- The Price-to-Earnings (P/E) ratio.
- The fund’s trading activity.
- Its position in the market.
- What type of management fees you’ll pay.
- The type of management the fund has.
This article will talk about the most important things to look for when deciding on an ETF to invest in.
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Table of Contents
8 Things That You Must Check Before Investing In ETFs
Underlying Index or Assets
Since ETFs are a basket of multiple stocks, bonds, or commodities, the first thing you need to determine is the assets that a fund holds. Some ETFs focus on a particular index like FTSE, while others contain assets from a single industry or geographic location.
In general, you should aim for diversification, which means that your ETF should incorporate assets from many spheres. Diversifying is a very prevalent advice for investors, and rightfully so, as it is the most critical factor for risk management.
Differences In the Tracking System
The tracking difference signifies the value of an ETF compared to the actual value of all its combined assets. For example, if the value of a particular fund’s assets is up 10.75%, the actual fund should also be up the same or as close as possible.
You might be surprised at how many ETFs display this crucial information incorrectly, so you need to make sure that the tracking error of the fund you’re investing in is very low or preferably non-existent.
Look for funds that are efficient and track their indexes tightly.
Tracking can depend on different determinants, such as:
- Some indexes are easier to track than others
- The skill and experience level of the ETF manager
- Is the ETF optimized?
Minimum Asset Level
To eliminate the risks that come with high liquidity and wide spreads, you should try to invest in ETFs with high asset value levels. A commonly used threshold is $10 million.
Funds valued less than that will generally have lower degrees of investor interest, which can be troublesome when trading. While it is possible to find some hidden gems that not many people know about yet, you need to ensure that people will eventually know about them, which can be very hard to predict.
For that reason, you will be better off sticking with already highly valued ETFs, especially as a beginner.
The Price-to-Earnings (P/E) Ratio
For seasoned investors, measuring a stock’s P/E ratio is one of the first things to do when evaluating a stock. To calculate the price-to-earnings ratio, measure the current share price of a company relative to its earnings per share.
You can apply the same formula to ETFs by considering all combined assets that make it up. The P/E ratio will give you a clue at how over/undervalued a particular fund is, which is an essential fact to know.
With a high P/E percentage, an ETF is either overvalued, or its assets are expected to grow exponentially soon.
The Fund’s Trading Activity
Before buying an ETF, you have to check its liquidity.
You do that by analyzing the level of trading activity each day, also known as the trade volume. ETFs that have at least $10 million of trading activity each day can be considered liquid. The more liquid a fund is, the tighter the ask-bid spread will be, which is especially important when trying to sell.
Another factor that affects a fund’s liquidity is the trading volume of the underlying assets that it holds. Even if the ETF itself isn’t trading frequently, if the shares it holds are liquid, the fund will have tighter spreads.
The trading activity also largely depends on the type of assets a fund holds.
For example, an ETF that consists of S&P 500 companies will typically be traded more than a fund made up of small Brazilian coffee producers.
Its Position in the Market
With thousands of ETFs out there, some can be mere knock-offs of an already popular idea. As in business, the “first-mover advantage” is also present in the ETF world, as the first one to issue a particular type of ETF will garner the majority of assets.
Make sure that the fund you’re looking at isn’t a mere knock-off. You’ll want to find the original one, as it will usually garner more attention and be more liquid.
What Type Of Management Fees You’ll Pay
ETFs and low fees are almost synonymous with each other. In fact, the low fees are one of the main reasons why so many people get into ETFs trading. With some ETFs, management fees can go as low as 0.07%, while the average cost ranges from 0.20% to 0.50% pa.
With that said, just because something is labeled as ETF doesn’t make it a given that it has meager costs. On the other end of the spectrum, some funds can have management fees of over 1%.
Traders must know the fees associated with a certain ETF before making any investments.
The Type of Management That the Fund Has
While ETFs were originally created in a fairly straightforward way, today, they can be quite different. Over time, as ETFs evolved, different management types appeared, each carrying their own level of fees and investment risk. Let’s take a closer look at the most common management types.
Index / Passive ETFs
As their name suggests, Index ETFs replicate an index based on market capitalization.
For example, the DE 30 index represents the 30 most prominent and most liquid German companies listed on the Frankfurt stock exchange. The corresponding ETF of that index is considered “passive.”
Because of their low risk and costs, Passive ETFs are the most popular choice, especially for novice investors.
Active ETFs
The Active ETFs market is still relatively small and only makes up 15% of total ETF trades. However, many investors expect massive growth in the future because of the much higher earnings potential.
An active ETF is a fund managed by a dedicated expert aiming to outperform the market and bring more significant profits to its clients. They are more of high-risk, high-reward investments and usually come with higher management fees.
Smart Beta ETFs
The smart beta management style is based on an index like the passive style but approaches it differently. Instead of merely focusing on market capitalization, the smart or strategic ETF looks at other factors to gauge the value of certain stocks and securities.
Some prevalent factors include:
- Financial factors
- Ethical factors
- Alternate evaluation of companies
- Market thematics
Because they are more advanced, Smart ETFs are generally more expensive, but that hasn’t stopped them from becoming very popular in recent years.
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Conclusion
Investing in ETFs has many upsides. They are very flexible, versatile, and you often get daily reports to check on your earnings. Before making a considerable investment, however, it is vital to look for a few things.
Checking on an ETFs underlying assets, tracking differences, liquidity, management fees are just some of the factors you need to look at before putting your money into ETFs.
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