Question

4. (a) As a stockbroker, you have been approached by a client seeking to establish a diversified portfolio of domestic shares. After identifying the client’s investment needs, you recommend the client use an exchange traded fund (ETF) to achieve her investment objectives. Explain to the client how an ETF will achieve the objective of a diversified share portfolio.

(b) The client also wishes to gain an investment exposure to the international share markets. Is it possible to use ETFs to achieve this objective? Explain.

Answer 1

a]

ETFs are exchange traded funds. This means that they are basically mutual funds, whose units are traded on the exchange.

Just like mutual funds, ETFs can be of several types based on the kind of investments they make. They could be equity ETFs, bond ETFs, indexed ETFs, balanced ETFs. etc.

Indexed ETFs are funds that track a specific index such as S&P 500, NASDAQ, etc.

An investor who desires to invest in a diversified portfolio of domestic shares can simply buy the S&P 500 ETF. S&P 500 ETFs are offered by many companies such as Citibank, Vanguard, Morgan Stanley etc.

These ETFs are designed to mimic the return of the S&P 500 as closely as possible. Thus, the weights of individuals stocks in the ETFs will be equal to their weights in the S&P 500 index

b]

Yes, as discussed earlier, ETFs are available for a wide variety of asset classes, including domestic shares, domestic bonds, international bonds, international equities, China equities, Asia equities, Africa equities, Europe bonds and so forth.

An investor who  wishes to gain an investment exposure to the international share markets can simply buy an ETF that focuses on international equities. For example, Schwab International Equity ETF is one such fund.