How to compare and select ETFs for your portfolio from a universe of 370+

As the Australian exchange-traded product (ETP) landscape continues to evolve and grow, investors have more choice than ever. But sometimes too much choice is its own challenge. There are now more than 370 ETPs listed on the ASX – so where do you start to filter down to find the options that are right for you?

To answer this question, we asked Vanguard’s Adam DeSanctis and Stockspot’s Chris Brycki for their tips on sifting through an ever-growing universe.

How to filter the universe

While it may be tempting to simply dive straight into the complete list on the ASX, both Brycki and DeSanctis are in agreement about the need to start with the basics.

Ask yourself the following two questions:

1. What are my financial goals?
2. Am I investing for the long or short term?

Then consider your investment strategy and asset allocation, along with the risk levels you are prepared to take. Then you can start to think about the securities that might embody the asset allocation you need.

When it comes to actually filtering through the universe, DeSanctis says there are two ways to consider ETPs.

“You can start with more of a building block approach where you go out and find broad-based ETFs that will get you exposure to each of the desired asset classes. 

There are also ETFs commonly referred to as diversified funds that might allow you to actually get broad-based exposure with one click of the button,” he says.

Understanding the different types of ETPs and whether or not they are suitable for you

There’s a common misconception that all ETPs are simple index-tracking vehicles. While Brycki mentions that 90% of flows are heading to vehicles like this based on Stockspot’s research, the landscape also includes considerably more sophisticated offerings.

The ETP universe today spans broad-based passive index trackers, more niche index trackers that might target a segment of the market, thematic ETFs with granular exposure to a particular theme, and actively managed products.

Brycki notes that broad-based index trackers tend to be the lowest-risk way to grow wealth over the long-term, whereas other forms carry more risk or may be unsuitable for many investors - like leveraged ETFs which have high funding costs and tend to be costly to hold for extended periods.

As DeSanctis cautions, “One of the lessons for investors to keep in mind is to make sure you understand the risk and what is actually in the product. For example, some products might have recommended holding periods that are shorter, perhaps one day.”

The key things to consider when comparing ETPs

Brycki and DeSanctis recommend the following characteristics to consider before pulling the trigger on an investment.

1. Costs

“The less you pay, the more you earn,” says Brycki, highlighting the importance of compounding where fees can really cut into your long-term performance. DeSanctis adds that you need to also factor trading costs involved with ETFs.

2. Past performance

“Ensure that the ETF is actually performing well versus the index,” says DeSanctis.

3. Index methodology

Get a sense of what you are investing in and how this might be correlated to other investments you hold. For example, Brycki points out that the S&P 500 and Nasdaq 100 indices have 70% overlap in stocks, so having both wouldn’t offer you adequate diversification.

Building a portfolio with ETPs

Just as with any investment portfolio, diversification is critical.

“When we think about a diversified portfolio, you have your percentage of equities, your percentage of fixed interest, maybe a little bit of cash depending on your personal situation,” says DeSanctis.

Brycki encourages investors to think about the correlations between different investment types because “in order to achieve great diversification and a smoother path to growing wealth, you actually want assets to do differently in different environments.”

He likes gold and government bonds as options that perform differently to equities.

And when it comes to adding in thematic investments, don’t forget to check against your other holdings in case you already have the same securities – as Brycki points out, he doesn’t need an AI thematic which includes Nvidia (NYSE: NVDA) because he already has that exposure in his broad-based US index selection.

A final word of caution

"It is common for investors to favour the companies that they're familiar with," says DeSanctis encouraging investors to be aware of home bias and look further afield to support better portfolio diversification.

"Be very careful about advertising because you'll never see an investment product that advertises a bad track record, but what we know is that 90% of products underperform very simple index funds over the long run," says Brycki, reiterating the importance of careful selection and looking deep into performance.