How exchange-traded funds (ETFs) work

What is an ETF?

ETFs are funds that issue shares, which are traded on a stock exchange. ETFs cover a broad range of asset classes and can give exposure to specific markets, sectors or investment strategies. Many ETFs track an index in order to provide this return.

How they work

ETFs can provide exposure to a variety of asset classes such as equities or fixed income by:

  • following the performance of a market index, such as the FTSE 100 or the S&P 500
  • following the performance of a smart beta index, such as S&P 500 Minimum Volatility or MSCI Europe Value
  • being actively managed by an experienced and dedicated manager

Why you may be interested

ETF investment strategies

Passive ETFs

Passive ETFs track a benchmark index such as the FTSE 100 or S&P 500. The performance of the shares and the market capitalisation of the companies within a particular index will be replicated closely by the ETF without the involvement of an active fund manager, keeping costs low.

Smart beta ETFs

Smart beta ETFs usually track an index that has been weighted to deliver a specific outcome, such as income or low volatility. Like other ETFs, they are traded like shares on the stock exchange and have the same unique benefits and risks. Because the indices that the smart beta funds track are more complex than for traditional ETFs, the cost tends to be a bit higher than for traditional ETFs.

Different types of smart beta
Whereas traditional indices such as the FTSE 100 are weighted based on the underlying companies market capitalisation, a smart beta index is designed based on other factors:

Minimum volatility smart beta
This ETF attempts to reduce exposure to volatility by tracking indices that aim to provide lower-risk alternatives. For example, a minimum volatility ETF might exhibit less risk during market turbulence compared with a broadly diversified index such as the FTSE All-Share. Some ETFs accomplish this objective by purchasing securities that exhibit relatively low volatility and concentration risk.

Income smart beta
Another factor that smart beta ETFs can be weighted on is income. By screening for stocks that deliver a dividend yield in excess of the market these ETFs can deliver an attractive income for investors. By screening for factors in addition to dividend yield, such as quality, these smart beta ETFs can further narrow down the companies that might be attractive for income investors.

Benefits of investing in ETFs

With ETFs in general you know exactly what you're investing in. Many ETFs provide daily visibility as to what securities the fund holds, how the ETF is performing and Total Expense Ratio (TER) costs. When investing in an ETF you know exactly what price you’re paying for units, unlike mutual funds.

Diversification

ETFs give you access to a whole world of investment options, covering a broad range of asset classes, sectors and geographies. This can help you to spread risks by avoiding putting all your eggs in one basket.

Cost effectiveness

ETFs often have lower costs than other types of investment funds.

Efficiency and access

ETFs are traded on stock exchanges, so you can easily buy and sell at any time during the day (provided the market is open).

Risks of investing in ETFs

There are, however, a number of things to consider.

Understanding the risks involved 

As ETFs invest in a wide range of asset classes, their value can go up as well as down and you may get back less than you invest.

Tracking difference

Even after charges are taken into account, most ETFs will not follow an index perfectly. The gap between performance and the returns from an index is called ‘tracking difference’.

Choosing an ETF

Explore our full range of ETFs to search, filter and select your favourite, including the iShares Core Series by BlackRock and our smart beta ETFs.

iShares Core Series by BlackRock

iShares logo

iShares are a family of exchange traded funds (ETFs) managed by BlackRock. The iShares Core Series offers nine funds giving you access to a range of the most common types of investments, that could be used as the foundation of a portfolio. This includes UK stocks, international stocks, and UK bonds.

The funds are built to the same professional quality that investors expect from iShares and are available at a low cost.

ExposureFundsDescriptionOCF
UK Equity iShares Core FTSE 100 UCITS ETF Access the UK’s largest blue-chip stocks in a single trade 0.07%
UK Government Bonds iShares Core UK Gilts UCITS ETF Access a well-diversified portfolio of UK government bonds (gilts) 0.20%
Eurozone iShares Core EURO STOXX 50 UCITS ETF Access the leading companies of the eurozone in a single trade. 0.10%
Asia and Emerging Markets iShares Core MSCI EM IMI UCITS ETF Access 99% of the emerging world's equity market. 0.25%
Japan iShares Core MSCI Japan IMI UCITS ETF Gain broadly diversified exposure to Japanese companies.  0.20%
Pacific Ex Japan iShares Core MSCI Pacific ex-Japan UCITS ETF Express a view on the Asia-Pacific region ex Japan. 0.20%
Global iShares Core MSCI World UCITS ETF Access 85% of the developed world's equity markets. 0.20%
North America iShares Core S&P 500 UCITS ETF Gain broadly diversified exposure to US stocks. 0.07%
GBP Corporate Bonds iShares Core £ Corp Bond UCITS ETF Access a diversified portfolio of investment-grade sterling-denominated corporate bonds. 0.20%

Fidelity smart beta - Quality Income ETFs

Fidelity has two Quality Income ETFs, one tracking a US index and the other tracking a global index. These funds screen companies for dividend yield and quality criteria, with the intention of offering investors an attractive income-based total return. Stocks of companies that generate superior profits, strong balance sheets, and stable cash flows would generally be considered high-quality.

Fidelity Global Quality Income ETF Inc GBP

Fidelity US Quality Income ETF Acc GBP

Fidelity US Quality Income ETF Inc GBP

Remember, the value of investments and the income from them can go down as well as up, so you may get back less than you invest. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment.