EXCHANGE TRADED PRODUCTS
Why Use ETFs? Transparency Liquidity • Investors can generally see the ETF composition at any given time
• ETFs offer two sources of liquidity: – Traditional liquidity measured by secondary market trading volume – The liquidity of the underlying assets via the creation and redemption process
• ETFs provide immediate exposure to a basket or group of securities for diversification Diversification • Broad range of asset classes: equities, bonds, commodities, investment themes etc.
Flexibility Cost Effectiveness
Securities Lending
• ETFs are listed on exchanges and can be traded at any time the market is open • Pricing is continuous throughout the day
• ETFs offer a cost-effective route to diversified market exposure
• The average total expense ratio (TER) for equity ETFs in Europe is 41 bps versus 96 bps (per annum) for the average equity index tracking fund and 187 bps (per annum) for the average active equity fund (1)
• ETF units and underlying assets can be lent out to potentially offset holding costs 1. Source: Strategic Insight Simfund Global, BlackRock Investment Institute – ETF Research, data as at end January 2011.
allows investors who are restricted from using derivatives or other commodity vehicles to gain exposure in an equity vehicle. Historically, commodities are one of the few asset classes to
have benefited from rising inflation. As demand for goods and services increases, prices of those goods and services usually also rise – as do the prices of the commodities used in their production. Because commodity prices tend to rise in periods of inflation, investing in commodities can potentially provide some portfolio protection against accelerating inflation. Another selling point in favour of commodities is that they have often proved more resilient than other asset classes to geopolitical and macro-economic shocks. Indeed, as is the case in the oil markets, these risk most immediately manifest themselves in sharp price rises.
Allocations to commodities stem from a mixture of strategic and tactical reasoning
Indices are a convenient way to access a group of commodities. They can represent the asset class as a whole or a particular sub-sector, such as energy, agriculture or precious metals. Allocations to commodities stem from a mixture of strategic and tactical reasoning. Similarly, investment returns can be both cyclically and secularly bullish. And given the capacity constraints in many parts of the complex the returns can be as varied as they are volatile over short time frames. In the recent market turmoil, many investors
have become concerned about counterparty risk, transparency, liquidity, product structure, cost, the use of derivatives and structured products. As a result, many investors believe ETFs offer
significant advantages due to their fund structure, trading flexibility, liquidity, diversification, relatively low cost,” according to Deborah Fuhr, Managing Director and Global Head
Exchange Traded Commodities Commodity ETF exposure can be based on different types
of underlying investments/vehicles which also leads to significant difference in performance: be it in equities, physical commodities or futures. The factors to consider stem from the investment objective and appetite for risk in the first instance. Selecting the right ETF, risk profile, index methodology and regulatory considerations are all key to the selection process – not forgetting the total costs associated the investment (including trading costs, tracking risk, registrations, trading currency, dividend withholding rates, taxes, and securities lending within the fund and lending of the ETF). Liquidity is another essential element. ETFs afford investors
two forms of liquidity. The first is through trading the shares on a secondary basis on-exchange. The second is on a primary basis via the unique ‘creation’ process, whereby an Authorized Participant purchases the underlying basket of securities in the local market and deposits the basket ‘in kind’ into the ETF, creating more shares in that ETF. The unique creation/ redemption process means that the liquidity in the ETF is driven by the liquidity in the underlying securities. Similar indices can have different liquidity profiles based on their index methodology. Divergence in the performance of an ETF, relative to the
index it tracks, is also possible. Differences tend to be caused by fund fees and expenses, tracking error when optimisation strategies are used to track the index, rebalancing due to corporate actions and index changes, or the dividend reinvestment policy of the fund.
September 2011 43
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