What is an exchange traded fund? According to Investopedia,an exchange traded fund (ETF) is a type of security that tracks an index, sector, commodity, or other asset, but which can be purchased or sold on a stock exchange the same way as a regular stock. An ETF can be structured to track anything from the price of an individual commodity to a large and diverse collection of securities. ETFs can even be structured to track specific investment strategies.
In the Philippines, an example of an ETF is First Metro Equity Exchange Traded Fund, Inc. (FEMTF), which aims to provide returns which would reflect the performance of the Philippine equities market by investing in a basket of securities which are included the Philippine Stock Exchange Index. You can actually buy this like any stock listed in the Philippine Stock Exchange (PSE). There are other investment vehicles that you can use to achieve investment returns that track the performance of the PSE Index such as the BPI Invest Philippine Equity Index Fund which is an open-end unit trust that invests in a diversified portfolio of stocks which are members of the index.
So what good is knowing all of this? It provides you with another investment option that allows you to better diversify your risk, look at the big picture and improve your chances of a more consistent rate of return. If you invest in an equity index fund, you are not just placing your bet in one or two companies but in dozens of companies that are in various industries, run by totally different people and operating in more diverse geographic locations.
An equity index fund is better able to reflect the movement of the economy in general. When the economy does well, companies typically do well also. However, we all know that there could be specific companies that get into trouble in spite of a good or even great economy. This is largely due to company specific issues such as mismanagement, fraud, politics, a fire burning down their factory, legal and regulatory issues.
Typically companies that are included in an index are well managed, more profitable, in high growth industries, have a track record and are also better known. These companies already have things going their way and buying the whole index really removes the uncertainty associated with a less diversified portfolio of say just a handful of companies.
Should you employ the same strategy in an index fund as you would in a single company stock? I wouldn’t. For one thing the volatility of the daily price movement of an index is much less than that of an individual company. Therefore, there is more certainty in the direction of the movement of an index than that of a single company, this allows you to sleep better at night. Forecasting the movement of an index is also a lot easier with more analysts crunching the numbers, looking at the charts and coming up with a narrower band consensus. All you need to do is wait for it to happen!
(The views and comments of the author are his own and not of the newspaper or FINEX. Comments may be sent to [email protected])