Using exchange-traded investments in your portfolio

Hargreaves Lansdown is a firm believer in the benefits of active fund management. A carefully selected, well-diversified portfolio of active funds is likely to produce higher long-term returns than passive funds, such as exchange-traded funds (ETFs). Trackers may be cheap but they believe potential outperformance is being sacrificed for cost.

However, some investors prefer the simplicity of the low-cost, passive approach. Also, unlike funds which typically deal daily, exchange traded investments (ETIs) can be dealt whenever the stock market is open. All you pay to buy or sell is normal stockbroking commission. There is currently no stamp duty payable on ETI purchases, but tax rules are subject to change.

For larger, more diverse portfolios ETIs can also offer private investors access to areas in which it would otherwise be difficult to invest, such as livestock or agriculture and markets, such as South Africa and Kuwait. Sophisticated investors can also use some of the more esoteric, higher risk ETIs to enhance the performance of their portfolio.

ETIs are not suitable for all investors, their value can go down as well as up, so you could get back less than you invest. If you are unsure of their suitability please seek advice.

Short term/strategic investments

Investments should be bought for the long term, but in some cases ETIs, and in particular exchange-traded commodities (ETCs), may be used as a short-term investment strategy. If you may think the gold price will rise in the next 3 months, for example, you could invest in a gold ETC and sell it once your target price has been reached.

Benefit from falling prices

If, on the other hand, you think the price of gold is going to fall, you could purchase a short gold ETC.

Short ETCs work on the principle that if the price of the underlying commodity/index falls by 1% during a day then the corresponding short ETC will rise by 1% during a day (excluding the costs of managing the ETI and any of the other factors that can influence the price). However, if the price rises investors who hold a short ETC will lose money.

Short ETIs can be used to protect gains already made by another investment or to gain from a drop in the price of the relevant index or commodity. Short investments are more complex than conventional investments and therefore should be regarded as higher risk.

Leveraged/geared investments

Leveraged exchange traded investments are very high risk and are intended for use by institutional or sophisticated investors.

Most leveraged ETIs work on a double leverage basis so if the price of the underlying index/commodity rises by 1% in a day the corresponding exchange traded investment will rise by 2% (excluding costs). Equally, if the index falls by 1% then, all other things being equal, the exchange traded investment will fall by 2%. However, it isn't possible to lose more than you invest.

Only investors who are willing to accept the risk of losing all of their capital should consider these investments. A couple of wrong positions could lead to substantial losses arising very quickly.

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