ETFs and index investing explained

What is an ETF?

An Exchange Traded Fund (ETF) is a type of investment fund that can be bought or sold on an exchange like the NZX, in the same way you buy and sell shares.

When you buy an ETF, you are issued units which are essentially shares in the fund. Each unit represents an equally valued portion of the portfolio of assets that the fund invests in.

Many ETFs track the performance of an index. This offers investors a cost-effective, diversified and transparent way to gain exposure to a broad range of assets, markets and sectors, while also simplifying the process.

Investors can use ETFs as building blocks to construct their own diversified portfolio to meet their financial goals and risk profile.

What is an index?

Indices are not specific to investing and are a measurement or indicator that can be made for almost anything.

In investing, an index is often used to represent and track the performance of securities within a specific market segment, asset class, sector, or investment strategy. An index is also a valuable benchmark for investors to compare performance.

Think of it as a recipe: each index has rules or criteria to determine which securities it includes. For example, the S&P 500 Index consists of 500 of the largest listed companies in the United States.

Another example is the S&P/NZX 50 Index, which represents the 50 largest companies listed on the NZX. The weighting of each company is based on its market capitalisation (the total value of a company’s shares). Whereas the S&P/NZX 50 Portfolio Index represents the same 50 companies, but the weighting of each company in the index is capped at 5%. This prevents any single company from having too large an influence on the index’s performance.

Only companies that meet the requirements or ‘the ingredients of the recipe’ will be eligible for inclusion in the index.

Who determines the recipe of these indexes? Index providers, such as MSCI and S&P Dow Jones Indices, construct and monitor these indices. Each provider uses a unique, rules-based methodology to build their indexes.

Over time, indexing has evolved beyond well-known, traditional approaches and shares, to cover all major asset classes, including fixed income, currencies, commodities, and real estate. Advancements in technology have allowed indexing to delve into more precise and more targeted exposures.

What is index investing?

Index investing or indexing is a style of investing that has grown alongside technology. Indices are not directly investable — investors can gain exposure to indices through investment vehicles such as index-tracking funds or ETFs.

An investor can build a portfolio by selecting an index to follow. However, replicating an index can be challenging and costly to do on your own. For example, if you want to build a portfolio that includes all the stocks in the S&P 500 at their respective weights, this would mean finding the list of stocks, and then buying all of them at the same proportions, which would require over 500 trades. And you’re not done there. Those components change on a pre-set schedule, which is called a rebalance. In short, it is complicated and expensive for an investor to replicate an index.

Instead, investors can use ETFs to efficiently achieve the same goal at a low cost, with a wide range of choices that are easily accessed.

How are ETFs and indices linked?

Through Exchange Traded Funds (ETFs), an investor can get exposure to the range of securities in an index with the purchase of just one ETF unit.

Indexing has evolved so that investors can find an ETF for not just a particular exposure, but also a more specific objective or trend. For these reasons, index ETFs have revolutionised how investors can access markets, build portfolios, and achieve their investment goals.

ETFs simplify the investment process. Many ETFs are designed to invest according to the rules and criteria set by these indices, with the primary objective of tracking the performance of the index. By replicating the index’s composition, these ETFs eliminate the need for the extensive research that traditional fund managers conduct on individual investments, making them a cost-effective option. As indexing has evolved, investors now have access to ETFs that not only provide broad market exposure but also target specific objectives or trends.

Index ETFs have therefore transformed how investors build portfolios, access markets, and achieve their financial goals, often with lower costs compared to actively managed funds.

What’s the difference between an index provider and an index fund manager?

It's important to distinguish between index providers and fund managers. Fund managers like BlackRock and Smart manage funds, not indices.

Index providers license their indices to asset managers and other financial institutions for a variety of uses, including benchmarking investments.

Although often labelled as “passive” investing, index fund management involves active oversight to ensure that fund performance aligns with index performance. Portfolio Managers and index research teams apply their portfolio expertise and investment skills to consistently seek fund performance outcomes that align with index performance.

Benefits of index ETFs

Index ETFs offer several advantages:

• Diversification: With one purchase, you can gain access to a wide range of securities.

• Cost-Effective: Index ETFs typically have lower fees compared to actively managed funds.

• Simplicity: Index ETFs serve as building blocks for constructing a diversified portfolio that meets your financial goals. They are easy to access directly through Smart, via platforms such as Sharesies or InvestNow, or through financial advisers or brokers. Each option varies in terms of fees, investment frequency, and convenience, where you need to consider your personal needs and timeline.

How to invest


Approaching index investing

How you approach index investing will depend on your individual circumstances and financial goals. Creating a diversified portfolio involves assessing your investing timeframe, financial goals, risk tolerance and circumstances. These factors will guide your asset allocation, which describes how your portfolio is spread across the primary asset classes: cash, bonds, property, and shares.

Cash and bonds are typically grouped as ‘income assets,’ while property and shares are categorised as ‘growth assets.’

Deciding how to allocate a portfolio between ‘income assets’ and ‘growth assets’ is an important decision. Income assets generally offer lower risk but more modest returns, whereas growth assets carry higher risk with the potential for greater returns.

Generally speaking, investors with a higher risk tolerance and a longer investment horizon may favour a greater allocation to growth assets, while more conservative investors may prefer a higher allocation to income assets.

How to invest in Smart ETFs

Smart ETFs are listed on the NZX and can be bought and sold like other listed shares. You can buy Smart ETFs through any NZX Participant, your financial adviser or broker, or via an online trading platform.

Smart also accepts direct investments from new investors for a minimum initial investment of $500 per fund, and from existing investors for as little as $50 per month. This service is designed for those looking to save regularly into Smart ETFs and is available for purchases only. To sell your ETF that you purchased from Smart, you need to contact your broker or financial adviser.

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