Key takeaways: 

• Passive and actively managed ETFs differ in how they seek to track their underlying indices. 

• ETFs could be suitable for many types of investors, and the current generation of funds even allow for targeted exposure to specific investment themes. 

• While it is useful to review management fees and historical returns, these should not be your only focal points when choosing an ETF. 

• It is important to do your own research before making decisions about investing. 

In 2024, the Australian ETF industry passed the $200 billion mark for total assets under management. That followed a strong period for global markets, and rising interest in ETFs on account of their cost-effective, efficient, and diversified nature. 

Despite high levels of awareness regarding ETFs, there are still some common myths that often lead to misunderstandings when it comes to investing in an exchange-traded fund. Here is a brief overview and response to some of the most common ETF myths. 

Myth 1: ETFs deliver the same performance as their underlying indices 

While passively managed ETFs typically seek to deliver the returns of the underlying index they track, there will be differences when it comes to the fund’s performance. This is referred to as a tracking difference. This difference is generally modest. However, it is possible that the performance differential is somewhat larger.  

There are a few reasons behind why this might be: the impact of fees imposed by the fund manager, the replication method used to track the index — either synthetic, where derivatives are used to replicate performance, or physical, which targets the same underlying assets as the index — and the timing of transactions designed to ensure a fund mirrors the holdings of its benchmark target.  

Meanwhile, actively managed ETFs rely on an investment manager to make decisions regarding the fund’s assets. The fund manager may deviate from a benchmark index in an effort to outperform that target, which means overall returns are less likely to deliver the same performance as an index. 

Myth 2: ETFs only suit a certain type of investor 

There is a misconception that ETFs are only intended for investors who don’t have time to follow the market, or the confidence to invest in individual stocks. And while that may apply to some, the reality is that ETFs can be suitable for a much broader variety of investors. 

This includes whether you’re new to investing or a seasoned professional. Risk averse or risk tolerant. Young or old. Choosing local or international shares. Targeting income or growth. A day trader or a long-term investor. ETFs can suit a wide variety of personal financial circumstances and goals, but as always, it’s critical to thoroughly research the product you are investing in. 

Myth 3: I should choose the ETF with the lowest cost 

While management fees and other associated costs are an important consideration when choosing an ETF, they should not be the sole focus. There are many other things to consider when investing in ETFs, from investment goals to desired exposure, underlying holdings, liquidity, and long-term performance. 

In terms of performance, while fees do detract from overall returns, ETFs with a higher management fee can still outperform comparable products with a lower management fee. 

Myth 4: ETFs with the highest returns are best 

Following on from the above, it is very important to make a clear distinction when it comes to the performance of an ETF, or any other financial product for that matter. Past performance is not an indicator of future performance. 

An ETF that boasts a stronger historical performance is not guaranteed to outperform another fund from the time of investment. It may be helpful to review historical performance when comparing ETF products, but you should consider this alongside other criteria. 

Myth 5: ETFs can only provide broad exposure 

Naturally, ETFs are known for offering diverse exposure to a broader market target, such as the ASX 200 or the S&P 500. In many cases, broad market ETFs are preferred. However, there are also a significant number of ETFs now designed to offer a narrow focus on a specific investment objective. 

For example, investors can invest in ETFs that choose to focus on exposure to specific sectors, industries, themes, assets and even geographic regions. ETFs may even follow rules that influence holdings selection and weight. In this respect, some ETFs don’t offer the same level of diversification that a broad market-tracking fund might, but they will still offer some level of diversification by virtue of the number of holdings in the fund.Debunking ETF myths 

ETFs are one of the most popular investment vehicles available, owing to their simple and efficient structures. However, this popularity also gives rise to some misunderstandings. In choosing ETFs, it is important to consider management fees and historical returns, but you should also look beyond these factors and assess other criteria like financial goals and risk tolerance that might determine product suitability.  

As with any type of investment, it is a matter of finding the most appropriate product, with consideration for broad or targeted exposure, and differences as far as passive and actively managed funds. Understanding these differences can empower investors to make informed decisions. 

Please undertake your own research and note that past performance is not an indicator of future performance.