FOOL SCHOOL
ETFs And Fund Supermarkets

March 23, 2005

Today's Fool School article looks at a couple of relatively recent developments in the exciting world of investing! Firstly, we look a new type of investment fund, the Exchange Traded Fund. Secondly, we look at a new way of buying funds, namely fund supermarkets.

Exchange Traded Funds

Exchange Traded Funds, or ETFs, operate as a sort of cross between unit trusts and investment trusts.

As far as private investors are concerned, they're closed-ended, like investment trusts. This means that they can avoid most of the administration costs involved with creating and cashing-in units. The flip-side of this is that ETFs are not organised to do this and you will have to find a broker to buy and sell them for you. If you want to invest in ETFs via an Individual Savings Account (ISA), then you'll need to get a 'self-select' ISA from a broker to put them in.

To the big institutions, however, ETFs appear open-ended, like unit trusts. So, if a big bank turns up with a few million in cash, then the managers of the ETF will issue some new ETFs for them. Similarly, if someone turns up with a few million of the ETFs, then the managers will turn them back into cash for them. The effect is that ETFs should trade very close to the value of their underlying assets, without the 'discount' associated with 'closed-ended' funds like investment trusts.

The ETFs currently available in the UK are known as iShares and they're index trackers. In other words, they track a particular stock market index. In the case of iShares, they aim to do it by fully replicating the shares in a particular index - giving a very small tracking error.

The most well-known iShare is the 'iFTSE 100' which tracks the FTSE 100 index. There's also the iShares S&P 500, which tracks the S&P 500 index in the United States, plus other funds which follow other major markets and corporate bonds.

Fund Supermarkets

One of the latest ideas to cross the pond is the fund supermarket. These have been in operation in the US for many years now but they only started to spring up here in the UK in 2000.

The name somewhat gives it away. It's a place where you can go to pick any sort of investment fund. Previously most funds were sold either through financial advisers or bought direct from the fund management company itself. However, because of the volume of funds that these supermarkets sell they can often offer some attractive discounts on the initial charges. These charges can be 5%-6% if you are buying direct. With a fund supermarket you might pay only a third of that.

Most fund supermarkets won't offer every single fund that is on the market, so if you have a specific fund in mind (perhaps in a specialist area) you might find it is not available through a fund supermarket. Like food supermarkets, fund supermarkets tend to offer only the most popular funds. They stack them high and sell them cheap.

Many supermarkets offer somewhere in the region of around 400 to 500 funds. This makes it simpler to choose a fund and many of them will have tools to help you choose the fund that is right for you. Some even offer telephone helplines, if you prefer the personal touch.

One final advantage that these supermarkets have is the ability to choose funds from several providers and put them in the same ISA. If you buy a fund directly you can usually only put funds from that fund manager into your ISA. A fund supermarket ISA allows you to mix and match, usually at no extra cost.

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