EXCHANGE-traded funds (ETF) have been seen by many as being one of the greatest financial innovations in recent decades. Offering retail clients cheap and highly liquid exposure to a huge range of markets, despite an initially slow uptake, there are now almost 1,000 ETFs on US exchanges alone.
If there’s a sector, there’s probably an ETF on it – from the short-lived HealthShares Dermatology and Wound Care ETF to the Market Vectors Mongolia ETF. If you can imagine it, a fund is probably being traded on it right now – the Global X Fishing Industry ETF being a case in point. Rather than attempting to pick out the best performing Japanese pharmaceutical stocks, just take out an equal-weighted Japanese Pharma ETF on the sector.
So, given the ease and simplicity of the exchange-traded fund, and its commodities-linked stablemate the exchange-traded note, why bother complicating things by spread-betting it – using a derivative to trade a derivative? “First of all, spread betting on ETFs is not a massive thing,” says David Jones, chief markets strategist for IG Index. Given that it is easy to spread bet on a number of indices, ETFs don’t really change things for the likes of the FTSE. But when it comes to more narrow sectors, ETFs cover areas where indices do not tread – for example the Brazil Small Caps ETF. But once again, why not just buy the ETF rather than spread bet it? The two answers to this are leverage and a quirk of inverse ETF repricing.
Though there are leveraged ETFs out there, spread betting allows you to ratchet up your exposure on any ETF there is – two or three times your risk or inverse risk. But many leveraged and inverse ETFs behave differently to how you may expect. Designed with day traders in mind, they reprice daily meaning that they do not give the same relationship as you might expect. If you took out an inverse ETF on the FTSE and it fell 2.4 per cent over the day, you might expect to see a 2.4 per cent gain in the inverse ETF. But the ETF might only be up 1.8 per cent due to repricing. This is where shorting an ETF by spread betting can give you leverage and give you inverse positions if you are looking for a direct relationship with the underlying market.
It is worth bearing in mind that taking a spread bet position on an ETF on a long-term basis may see any advantages wiped out by overnight funding costs that you will accrue. But for short-term exposure to a specific sector, spread betting on an ETF can avoid the commission on the ETF and give you the usual spread betting advantages of leverage and tax-free gains.