They could buy every member of the FTSE 100 in the correct proportions, take out a spread bet or even buy a futures contract on the Liffe exchange, but this is too complicated for most. The answer is to buy a FTSE 100 ETF.



ETFs (Exchange Traded Funds) are relatively new to the UK; originating in the US, they are funds, which track an index or market sector. You can buy and sell an ETF like you would Vodafone, Microsoft or any other share.

ETFs are created by financial institutions such as Barclays Global Investors and are listed shares on the London Stock Exchange. The ETF’s assets comprise of stocks or bonds in such a way as to be an exact analogue of the market sector, indices or asset groupings that it’s designed to track.

With a range of ETFs available, the idea is to give investors a one-stop shop to buy baskets of a certain kind of asset as a single listed share. ETFs represent and perform like broad segments of the market or a commodity, or an index like the FTSE 100 or S&P 500. They give the investor a simple user-friendly way to gain the benefit of diversification without the need to buy lots of different instruments; they can even be put into an ISA or a SIPP, just like a unit trust and most shares.

Rather than buy lots of shares in the FTSE 100 you can simply ring up your broker and buy the wonderfully named isharesiftse100 (ADVFN Ticker code: LSE:ISF.) iShares is the brand name for one of the world's largest ranges of ETFs, which is marketed and managed by Barclays Global Investors.

There are many reasons why an ETF is a good idea. Firstly it avoids the evil stamp duty that poor British investors are inflicted with. ETFs are domiciled outside the UK and thus avoid this blight. A 0.5 per cent punishment for investing compounds up into a huge loss for investors over their lifetime of saving.

While ETFs are traded like shares, owning one is none-the-less holding a fund. Management costs of an ETF are low, which directly equates to a low cost for the investor. The expense ratio of an ETF is around 0.5 per cent, while a Unit Trust is roughly double at nearly 1 per cent. With actively managed funds coming in at 1.5 per cent, holding an ETF represents a noticeable saving. This kind of penny pinching compounds to a significantly better return over the long term if, as theory tells us, passive tracking outperforms active management.

For the more active investor ETFs are priced in real-time unlike other funds, which fix their prices at the end of the day. This is a benefit for those who want to use them as a trading device.

According to Nobel prize-winning theorists, the best way to make money in the stock markets is to buy a broad portfolio of shares representing the average return of the market and hold on to that for as long as you can. The ETF is the perfect way to do this in one purchase.

The market index has done extremely well over the years and the market rate compounded over the years creates a heroic profit. Even after the nasty post-2000 crash someone who’d managed to track the index since 1984 would be holding around a 550 per cent profit.

Unlike shares that enter and fall out of the FTSE 100, you can buy and hold an ETF and get the benefit of the compounding without the constant drain of taxation on your holdings triggered by trading bits and pieces as they fall out of or enter the index list.

There are numerous ETFs available, meaning a diversified portfolio can be easily built internationally as well as across sectors.

Barclays Global Investors is a leader in the field and on the UK market they offer a broad spread of iShares covering the FTSE 100, 250, Euro 100, Eurotop 100, S&P 500, Euro Stoxx 50, DJ Stoxx 50 as well as Dollar, Euro and Sterling corporate bonds. Fourteen new iShares have been added since 1st October 2005. These include iShares MSCI Korea, iShares/EPRA European Property Index Fund and iShares € Inflation Linked Bond. These include iShares MSCI Korea, iShares FTSE/EPRA European Property Index Fund and iShares € Inflation Linked Bond.

On the US markets there are a plethora of ETFs made available not only by Barclays, but by State Street, Lipper, Vanguard, Merrill Lynch and others. US ETFs cover about anything you can imagine from national indices to biotech sectors and cyclicals. There is even a Broadband ETF care of Merrill Lynch.

In the US, the Nasdaq tracking QQQ and the S&P tracking SPDR are often used as trading devices to take speculative punts on the movement of the indices. The massive trading volumes of these ETFs underline the fact that their introduction is an important development for the British investor and the London market.

ETFs are still a well-kept secret. This is probably because there are no fat commissions to be had along a marketing chain. As such the message has been filtering out by word of mouth. Yet with the London Stock Exchange firmly behind the growth of ETFs and the benefits of the product so clear they are bound to grow in popularity.

This however is unlikely to dent the human urge to chase enormous returns however futile theory suggests this to be. So ‘Active fund managers’ and ‘Hedge funds’ have little to worry about from the ETF, unless of course someone can come up with a sexy name for them.