Five questions about ... exchange traded funds (ETFs)

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What is an ETF? Despite their starring role in the £1.5bn "rogue trader" loss at UBS, ETFs are popular with many investors as they offer a low-cost way to gain exposure to different markets or sectors.

They are basically tracker funds which are traded on stock markets in the same way as ordinary stocks and shares. However, there are also much more complex ETFs which use derivatives to produce returns, rather than directly holding underlying assets.

What can I invest in through an ETF?

ETFs can hold a lot of different assets including stocks, commodities and bonds. They are generally used to track an index such as the FTSE 100 or 250 or a particular commodity such as pork bellies, for example. Others track the performance of a country such as China or Brazil.

Why are they popular?

Their relatively low costs are one of the main reasons that ETFs are attractive: the average mutual fund costs about 1.4 per cent a year, while typical fees are nearer 0.32 per cent. Other advantages include tax efficiency and transparency. ETF owners know exactly what stocks or underlying assets they are holding, as opposed to mutual funds' investors who often only know a scheme's top 10 holdings.

How can I invest in an ETF?

Unlike traditional tracker funds, ETFs are actual companies that are traded in the same way as shares. Consequently, you need go through a broker, just as you would to invest in shares in Tesco or HSBC. There is no real minimum investment, though, while you also have the freedom of being able to invest for as long as you want.

Are they safe?

Like any other investment, the price will fluctuate but if you stick to basic ETFs which track indices such as the Footsie, you should know when prices rise or fall. ETFs linked to derivatives or commodities can be complicated and bring added risks.

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