Why rich people invest in ETFs

Exchange Traded Funds (ETFs) are investment vehicles that have gotten a lot of attention in 2022, as investors in developed economies are looking for an edge against the market downturns that are being experienced in developed markets like the New York Stock Exchange (NYSE).

The all-share index (ASI) of the NYSE is down 2.23% Year-to-Date (YtD), with stocks like Shopify and Roblox down by 61.88% and 64.38% YtD. These levels of decline are seen across developed markets across the world as inflationary concerns have become the main focus of financial watchdogs who are taking steps to tackle the issue by increasing interest rates on government-backed securities.

ETFs are a way to hedge against market declines seen from holding an individual stock. This is because they are a type of pooled investment security that operates much like a mutual fund.

What are ETFs

An ETF, as previously mentioned, is a type of pooled investment security that operates much like a mutual fund, that tracks a particular index, sector, commodity, or other assets, but unlike mutual funds, ETFs can be purchased or sold on a stock exchange the same way that a regular stock can.

An ETF can be structured to track anything from the price of an individual commodity to a large and diverse collection of securities. In today’s advanced market and technology, ETFs can even be structured to track specific investment strategies.

ETFs hold assets such as stocks, bonds, currencies, futures contracts, and commodities such as gold bars, and generally operate with an arbitrage mechanism designed to keep it trading close to its net asset value. In today’s market, most ETFs are index funds, which means they hold the same securities in the same proportions as a certain stock market index or bond market index.

How it works

ETFs may seem complicated but there are very straightforward. Here’s how it works:

  • The fund provider owns the underlying assets, designs a fund to track their performance and then sells shares in that fund to investors.
  • Shareholders own a portion of an ETF, but they don’t own the underlying assets in the fund. Even though they don’t own the assets in the basket of the ETF, investors in an ETF that tracks a stock index may get lump dividend payments, or reinvestments, for the stocks that make up the index.
  • While ETFs are designed to track the value of an underlying asset or index, be it a commodity like gold or a basket of stocks such as the S&P 500, they trade at market-determined prices that usually differ from that asset.
  • What’s more, because of things like expenses, longer-term returns for an ETF will vary from those of its underlying asset.

How to pick an ETF that suits you

Investors interested in ETFs should start by figuring out what they want from their portfolios. Questions like, Slow and steady growth? A focus on emerging technologies? A commitment to companies dedicated to socially and environmentally responsible practices?, need to be answered as there are thousands of ETFs with different focuses exist.

Once an investor knows what they want from their portfolio, they can conduct research and identify one or more ETFs that are a good fit for their needs. Because ETFs trade on stock exchanges, they can be bought and sold easily on stockbroking platforms. For those looking to invest passively and consistently, dollar-cost averaging may be a simple and sustainable ETF investment strategy.

Why ETFs?

  • A major benefit of ETFs is the limitation of the risks and potential losses that come with owning a particular stock or any asset class for that matter. ETFs make it so that investors are easily safeguarded from the exposure one stock could bring as the ETF carries along with a basket of asset classes that help limit potential loss that may occur.
  • For instance, Netflix is down over 60% YtD. If an ETF was created with Netflix and two other stocks Stride and Natural Grocers by Vitamin Cottage, which are up by 21.81% and 62.25% respectively, the total loss seen on Netflix will not significantly weigh down your ETF position.
  • Another reason to own an ETF is that they provide lower average costs because it would be expensive for an investor to buy all the stocks held in an ETF portfolio individually. Investors only need to execute one transaction to buy and one transaction to sell, which leads to fewer broker commissions because there are only a few trades being done by investors.

ETFs in Nigeria

The Nigerian Exchange (NGX) is the leading ETF market in West Africa and one of the largest in Africa in terms of its listed products, turnover value and market capitalization. Since the first listing of a single commodity-backed ETF in 2011, a number of other equity-based and fixed-income ETFs have been introduced into the Nigerian bourse. NGX offers a fully electronic trading platform that delivers the benefits of deep liquidity, transparency and tremendous speed and efficiency.

ETFs on the NGX are listed on the exchange and trade much like stocks. They provide Nigerian investors with the opportunity to diversify their investments at relatively lower costs and gain exposure to different asset classes and strategies including; Equities, Fixed Income, Commodities, Currencies, International Markets, Multi-assets and so on.

On the exchange, there are currently 12 ETFs that are listed. They have a market capitalization of N7.1 billion as of the time of this writing.

Bottom line

ETFs also provide access to many stocks across various industries, proper risk management through diversification and also provide exposure to stocks of a targeted industry. For example, an EV ETF gives the buyer exposure to companies that produce Electric Vehicles.

ETFs are a good way to hedge against potential losses that may occur as a result of worrying macro-economic factors that we are seeing today, caused by the ongoing war between Russia and Ukraine and the actions of financial watchdogs.

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