It is important to understand that ETFs are not guaranteed products – just like any investment in the stock or bond market, your initial investment is subject to risks.
As there are many different types of ETFs, there are some that are riskier than others. If you invest in an ETF that holds securities in a currency other than your own (for example a Japanese equity ETF), your returns can also be affected by movements in the exchange rate (AUD vs JPY). There are some ETFs that provide currency hedging to minimise this ‘currency risk’. ETFs are designed to track an index, therefore they buy the same securities as that index and attempt to replicate the returns, minus the cost (fee) of the fund. There is a risk that there can be a divergence between the return of the index, and the return of the fund. However, it should be remembered that it is impossible for any investor to invest directly in an index.
Risk is an inherent part of investing. Every investment portfolio carries some degree of risk and by better understanding the types of investment risk, investors can manage portfolios’ risk/return balances through market cycles.
What is more, the elevated risk associated with higher volatility can present opportunities for investors aiming to enhance portfolio returns.
How ETFs can help manage risk
ETFs can help investors diversify across asset classes and risk exposures, customise active risk, and adjust expected portfolio volatility.
For example, using ETFs, investors can quickly and easily reduce exposure to equities in times of market volatility, at the same time increasing exposure to fixed income.