[This article was first published on the Learn section of our website]
There are well over 1000 ETPs listed on the London Stock Exchange, which ones are right for you?
With more than 900 ETPs listed on the London Stock Exchange and close to 5,000 available globally, choosing the right one can be tough. But as we’ll demonstrate below, it is also critical, because two ETPs that claim to promise the same exposure can actually deliver very different returns.
By far the most important decision when choosing an ETF is selecting the kind of exposure you want. Even ETFs whose names suggest they track the same market in fact provide very different returns.
Here’s an example: The iShares FTSE China 25 ETF and the db X-trackers CSI 300 ETF both sound like they provide exposure to China, and they do. But they provide very different exposure to different share classes and liquidity pools within the broader Chinese market place.
So how do you find the right one for you?
Since most ETPs track indices, the most obvious place to start is with each ETF’s index. Look at the securities that comprise the benchmark, from their sector to their size to their country of domicile. Do they match the asset allocation you have in mind?
Once you know what securities are in the ETF, examine the methodology the index uses to select and weight its holdings. Some ETFs rely on passive, well-established indices, while others track newer, more innovative benchmarks whose constituents can change quite frequently.
Do the largest companies in the index get the largest weight (so-called market-cap weighting), like the FTSE 100 and the S&P 500? Does the ETF use an alternate approach, such as equal or fundamental indexing?
While it’s perhaps frustrating that you can’t stop your investment process with “I want to be in China”, the reality is the Chinese investment universe is not as easily defined as its geography.
(See our article, “Understanding Financial Indices” for more information.)
After determining which ETF provides the exposure you’re really targeting, most investors rightly turn to the question of cost. Considering that a fund's expense ratio is the single greatest indicator of its future tracking difference, it's no surprise that low expense ratios are highly sought after.
The most critical cost to look at is the “total expense ratio”, which reflects the overall costs to manage and operate the fund. Bigger fees don't equate to better funds so looking to low-cost options may be a good first-step. (For more, see our article Total Expense Ratio)
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