Exchange traded funds (ETFs)

As you can see from my table, there are a lot of different ETFs that serve different purposes.
Most offer some combination of the following:

• Diversification in one stock
• Access to alternative assets
• Professional management
• Low Costs
• Liquidity

Let's examine those individually.

Diversification

Modern portfolio theory assumes that you want to maximise your return and minimise your risk. Harry Markowitz figured out that diversification into uncorrelated assets does exactly that. Later research showed that as few as 20 stocks in different sectors will give you the market return without individual stock risk. But for smaller investors, buying and managing 20 stocks is not feasible. Smaller parcels attract a higher transaction costs and monitoring and managing takes time. An index fund will buy all of the stocks that make up that index for you, providing a basket that you can put all your eggs into.

Access to alternative assets

Some ETFs invest in bonds, precious metals, commercial real estate and other assets that are difficult for retail investors to get direct exposure to. Continuing with the theme of diversification, to get less than stock market risk, you need assets other than stocks. ETFs can give you that.

Professional Management

While "tracker" funds use computer algorithms to hold the same basket as the index, some funds attempt to beat their benchmark by smarter asset allocation. It's an attractive thought. Put your money with a manager that has a lifetime of experience, a network of contacts and access to the best analysis. But it's a crowded field with many firms trying to beat the index and charging fees to do it. On average they should perform ... well average, and when you subtract the fees, you may be better off just buying the index.

Low Costs

Many funds charge one tenth of one percent or less. Typically the tracker funds operate very efficiently.

Liquidity

Most ETFs can calculate their net asset value (NAV) instantaneously. Many have an independent firm calculate the iNav (interactive NAV) every 15 seconds during the trading day. It's usually shown on their web page. Liquidity can be provided by market makers, independent firms that bid and offer units around the NAV making a small percentage for providing liquidity.

What if a lot of investors want to buy or sell at the same time? That could overwhelm the market-makers and push the price up above fair value or depress it below the NAV. The beauty of ETFs is that they are open ended and can increase or decrease the number of units. In this case the ETF provider itself would step into the market and buy or sell units. When they have too much cash, or too little, they can simply adjust their holdings, eg sell some of the basket to pay sellers or buy more assets, increasing FUM. This is a lot better than traditional managed funds that calculate NAV infrequently and may halt redemptions when volatility is high.