ETFs: what you need to understand
ETFs take up a growing share of portfolios. The principle is simple, but a few mechanisms are worth understanding before holding one, if only to read its performance correctly.
An index fund that trades on an exchange
An ETF is a fund that seeks to reproduce the performance of an index, and whose units trade on an exchange like an ordinary share.
Two things follow. First: holding a unit amounts to holding a fraction of every security in the index, which gives broad exposure through a single line. Second: the price moves continuously during market hours, unlike a traditional fund valued once a day.
Physical or synthetic replication
A physically replicating ETF actually holds the index securities, in full or by sampling.
A synthetically replicating ETF does not hold them: it obtains the index performance through a swap contract with a counterparty, usually a bank. The intended result is the same, but it adds counterparty risk, regulated but real. This appears in the fund documentation, under the replication method.
Tracking difference and fees
An ETF never reproduces its index exactly. The gap between the two, the tracking difference, comes from management fees, transaction costs and the treatment of dividends.
Headline fees therefore do not tell the whole story: two funds quoting the same fee can track their index with different fidelity. Over a long period, that gap compounds like everything else.
What the index actually contains
Buying an ETF means buying an index, and indices are not neutral. Many weight companies by size, so the largest capitalisations make up a major share.
A broad index can therefore be far more concentrated than it appears, in a handful of companies or sectors. Checking the composition and the top holdings avoids believing in a diversification that is not there. In Finvygo, an ETF is tracked like any other position, valued automatically, with its weight in your net worth.
An ETF is a tool, not a uniform category: two funds tracking the same index can differ in replication method, fees and tracking fidelity. These details sit in the fund's regulatory documentation, which is worth reading before investing.
Ready to take control of your wealth?
Join Finvygo for free and start tracking all your assets in one place.
Create my free account