Thursday, 17 February 2011

Buying an Exchange Traded Fund (UK)

Buying an Exchange Traded Fund or ETF is Level 4 of the Income Pyramid in the DIY Income Investor approach, and should be done only after paying off debts and building up a safety buffer of cash in 'easy access' bank accounts and in fixed rate savings bonds.

An ETF is a low-cost collective investment that is spread over a diversified selection of similar types of individual investment, so it minimises your risk of catastrophic loss. This is why we recommend ETFs as the entry point to stock market investing. If you're not familiar with investing, I suggest that you use ETFs for a couple of years, until you get the hang of the 'ups and downs' of the market - and what these mean for the different types of investment. This advice is based on my own hard experience - so only move onto investing in individual companies or bonds when you have understood fully how they work. Prepare to be slightly bored for a while...

Three types of ETF are suggested - all targeted at generating income rather than capital growth:
  • government gilts
  • high yield company shares
  • corporate bonds
Which one you choose depends on your own tolerance for risk and the inevitable ups and downs of the market. Government gilts are pretty secure but the rate of return is lower. As with all investments of this type the value of the ETF will fluctuate - and may be less that you paid when if you need to sell quickly.  This is why you need a good cash cushion to avoid the need for a 'fire sale'.  On the other hand the income is likely to remain stable or even to grow (in the case of the dividend ETFs).

Any ETF should be bought within a tax-protected account - in the UK an ISA.

In this post I'm looking at a ETFs available in London but similar ETFs are available in most major markets - List of worldwide high-dividend ETFs.

iShares FTSE UK Dividend Plus ETF (IUKD-LSE)

iShares FTSE UK Dividend Plus ETF aims to track the performance of the FTSE UK Dividend+ Index as closely as possible. The ETF invests in physical index securities and offers exposure to the 50 highest yielding UK stocks within the universe of the FTSE 350 Index, excluding investment trusts. Stocks are selected and weighted by one-year forecast dividend yield.

For further information about the ETF see here.  The top holdings are shown here - and include the biggest names in the London Stock Exchange.

The ETF is bought like any other stock and - beyond the normal 'spread' (between buy and sell prices) - there are no initial fees; the annual fee is only 0.4%.

Dividends are paid quarterly.In mid-February 2011, the dividend yield was 4.4% and the one-year return was over 21% (although over 3 and 5 years the ETF was showing a loss - like most of the stock market).

See a discussion from Motley Fool on this ETF when it was launched here and an analysis here of the costs of an ETF (compared to the more sophisticated DIY approach - which I would expect most people to advance to eventually). A more recent appreciation here - the sentiment is that it is perhaps more a capital growth seeker using income streams as a buy/sell signal.

iShares Markit iBoxx £ Corporate Bond (SLXX)

iShares Markit iBoxx £ Corporate Bond is an exchange traded fund (ETF) that aims to track the performance of the Markit iBoxx £ Liquid Corporates Long-Dated Bond Index as closely as possible. The ETF invests in physical index securities and offers exposure to the 40 largest and most liquid Sterling denominated corporate bonds with investment grade rating. Only bonds with a minimum remaining time to maturity of 1.5 years and a minimum amount outstanding of £250 million are included in the index.

In February 2011 the fund had 57 holdings  with a distribution yield of 5.7%, although then one-year return was only 4.5%; the expense ratio was 0.2%.  For more details see here.

iShares Markit iBoxx £ Corporate Bond ex-Financials (ISXF)

iShares Markit iBoxx £ Corporate Bond ex-Financials  is similar to SLXX above but excludes bonds issued by financial institutions, which have been at the heart of recent worldwide financial turmoil.

More details here. The mid-February 2011 distribution yield was 4.7% and the one-year total return was 7.1%.

iShares FTSE UK All Stocks Gilt (IGLT)

iShares FTSE UK All Stocks Gilt ETF aims to track the performance of the FTSE Actuaries Government Securities UK Gilts All Stock Index as closely as possible. The ETF invests in physical index securities and offers exposure to Sterling denominated UK government bonds (conventional gilts) quoted on the London Stock Exchange, other than index-linked bonds.

For more details see here. In mid-February the distribution yield was 3.5% and one-year total returns were 4.6%. Distributions are made every half-year.

iShares Barclays Capital £ Index-Linked Gilts (INXG)

This ETF is similar to the preceding one but focuses on index-linked gilts. More details are shown here

In mid-February 2011, the distribution yield was just under 2.3%; the one-year total returns were just under 7.5%.


I am not a financial advisor and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.

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