The exchange traded fund world is huge. As at 31 July 2017, ETF assets stood at £3.2 trillion invested. According to Simfund, in the first quarter of 2017, ETF inflows hit an all-time high of £97.5bn, so the evidence is clear that they are, and are increasingly becoming, an important part of the investor toolkit.

The simplest form of ETF is one that owns the market, essentially replicating the holdings of a particular index such as the FTSE 100. There is no fund manager determining which companies to invest in and thus the costs are lower than actively managed alternatives. This is a fairly easy to understand concept, however it is just the tip of the iceberg in terms of what types of ETFs are available to the investor.

What started off as a very simple concept, however, has developed considerably since those early days. One area of the market that is becoming increasingly interesting, and that we have been utilising for many years, particularly in our Close Tactical Select Passive Funds, is that of 'smart beta' ETFs. Smart beta ETFs currently represent approximately one fifth of the assets invested in ETFs.

Smart beta ETFs cover a broad spectrum of funds explained in more detail in the linked article. In very simple terms, they offer passive investment into indices based on a number of factors ranging from corporate profitability, volatility, dividend yield, market capitalisation and so on. This makes it easy to exclude or include companies or investments with the type of characteristics that you are looking for.

They are typically slightly more expensive than standard index-replicating ETFs, but remain considerably cheaper than actively managed funds. They offer an excellent way to give your portfolios a style tilt towards growth, value, quality etc. and avoid unattractive areas of the market that an index replicator would have to own. 

In our experience, however, it takes a significant amount of research to make sure that you really know what you are buying and they can be a potential minefield for the less experienced investor who might not understand the complexities and implications of the strategy being undertaken. Then there are other considerations such as cost, bid offer spread and liquidity, which are all vital considerations when deciding which ETF to own.

The moral of the story here is that the ETF market is becoming an increasingly important part of the global investable universe, however with that comes increasing complexity, risk and the necessity to thoroughly research the available options.