020 7189 9999
Opening hours
Mon - Fri: 7.45am to 6pm (Thurs 8pm)
Sat: 9.30am - 1.30pm
Request a call back

ETFs explained

Many ETFs are similar to index or tracker funds, reflecting the basket of securities that constitute a chosen index. ETF shares are listed on an exchange, such as the London Stock Exchange, and can be bought and sold in the same way as a company share or investment trust when the exchange is open. The price of an ETF share is priced off the underlying equity index that it is designed to track.

An ETF will attempt to replicate an index by investing in the same assets in the same proportions as that index. When shares are created, the ETF purchases a portfolio of stocks closely approximating the index. By buying one ETF share you get an equivalent performance of the index that it replicates, less any fees or charges the ETF has to pay. ETFs that replicate an index are passively managed funds and there is no stock selection by a fund manager so fund management fees are often much lower.

Traditionally, most ETFs tracked well-recognised indices such as the FTSE 100 or the S&P 500. However, more recently, we have seen the launch of new ETFs now that track more risky and exotic markets. This gives the retail investor the opportunity to access markets that were previously only available to professional and institutional investors.

Synthetic ETFs

Some ETFs aim to replicate the performance of indices by using derivatives (for example swaps) rather than shares. These funds are known as ‘synthetic ETFs’ (in contrast to the ‘physical’ replication described above where a fund buys the underlying asset). Synthetic ETFs can be launched faster than cash-based ETFs which may give them more flexibility. However, synthetic ETFs expose investors to the risk of losing money in the event that the party supplying the derivative becomes insolvent. It is often not immediately obvious whether an ETF invests in shares or is based on derivatives, so it’s important to understand this before investing.

Enhanced ETFs

Some ETFs use a range of enhancements and modifications in an attempt to (over time) beat the benchmark that they are tracking. This adds semi-active management to the process. There are ETFs using a wide range of different investment criteria to enhance returns, with specially designed indices based on company revenue, profits, dividends and various market ratios. These funds may choose to use derivatives on the index. Enhanced indices tend to have active management fees while using passive strategies.

Short/Leveraged ETFs

Short and leveraged ETFs are particular forms of ETF that carry significantly greater risks. Leveraged investments exaggerate the impact of market movements, and so the price will be much more volatile than the underlying asset. There is the potential to lose all of your capital. Some ETFs may also use derivatives to ‘short’ the index that is replicated. This has the effect of the fund generating profit when the index or market falls instead of when it rises (and therefore losing money where the index or market rises). Both short and leveraged ETFs are intended for institutional and experienced, sophisticated investors only. Please call us if you are interested in investing in these types of shares.

Exchange Traded Notes (ETNs)

ETNs work differently to ETFs and may be of greater risk than ETFs. Although returns are linked to the performance of a market or index in the same way as an ETF, they are technically a debt security. This means that their value may be affected by changes in the credit worthiness of the issuing firm. If the firm that issues the ETN goes bankrupt or its credit rating is downgraded, the ETN may lose value even if the underlying index is unchanged.

Exchange Traded Commodities (ETCs)

ETCs may use futures and derivatives to track movements in the value of commodities (such as gold, oil or wheat), or may hold the commodity in a vault with each share representing a proportion of the commodity held. Physical replication is largely confined to precious metal ETCs. Most other ETCs use futures. Investing in a specific metal, commodity or natural resource is a high-risk strategy and the use of derivatives may increase the risk of using ETCs.


It is important to understand the risks of any investment, including ETFs, before investing. However, the speed and breadth of innovation in ETFs means that the investor needs to consider carefully the specific risk of each ETF.


Past performance is not a reliable indicator of future returns

The value of your investment can go down as well as up, and you can get back less than you originally invested.

The Bestinvest Online Investment Service, including any account analysis and investment reports provided by our guidance services, is an online execution-only dealing service for investors who want to make their own investment decisions. It does not provide advice on the suitability of products and investments; if you are unsure about the suitability of any investment you should seek professional advice. Clients of our Investment Advisory Service and Managed Portfolio Service can use the website to obtain current valuations of their investments but cannot trade on these accounts online and should call their adviser if they wish to discuss changes to their investments.

Past performance or any yields quoted should not be considered reliable indicators of future returns. Restricted advice can be provided as part of other services offered by Bestinvest, upon request and on a fee basis. Before investing in funds please check the specific risk factors on the key features document or refer to our risk warning notice as some funds can be high risk or complex; they may also have risks relating to the geographical area, industry sector and/or underlying assets in which they invest. Prevailing tax rates and relief are dependent on your individual circumstances and are subject to change.

Issued by Bestinvest (Brokers) Limited (Reg. No. 2830297), which is authorised and regulated by the Financial Conduct Authority. Financial services are provided by Bestinvest (Brokers) Limited and other companies in the Tilney Bestinvest Group, further details of which are available here. This site is for UK investors only.
© Tilney Bestinvest Group Ltd 2016.

Version: RC1026.42402