Exchange Traded Funds (ETFs)

The first fund that can be described as an Exchange Traded Fund (ETF) was launched in the US in 1993. Steady growth ensued and by 1997 total assets under management in ETFs was approaching 7 billion.
Since then, the ETF market has taken off. It was helped in its rise by the stock market boom in the late 1990s, but, unlike technology stocks, the success of ETFs has not faded. On the contrary, the message of cost-effective, well-diversified investing has hit home amidst tough market conditions, making ETFs the ideal vehicle for modern investment strategies.

By June 2006, total assets under management of ETFs around the world topped 388 billion.
The success of ETFs in Europe has been no less spectacular. Assets increased by 29.9% during the first half of 2006 to over 55 billion. Final figures for 2007 have not yet been published.

Source: Morgan Stanley, August 2006

Key Features

Liquidity
High or low demand for an ETF is unlikely to affect its market price. If the demand for an ETF rises, new shares are created. This process works in reverse if the demand should fall. This ensures the ETF only represents the prices of the stocks it holds.

Transparency
The funds aim to reflect the performance of an index, so you always know what you are investing in. ETFs disclose their holdings every day, so you can see exactly what you hold in your portfolio. Traditional funds usually disclose holdings just twice a year.

Diversification
Rather than the higher risk strategy of concentrating on a few individual companies, investing in an index or indices gives you exposure to entire markets. This means you can still make targeted investments in your chosen areas, but with more control of risk.

Cost-effectiveness
The cost of investing in ETFs is generally less than in most actively managed equity funds and equity index funds. They are also more cost-effective than holding individual stocks. To achieve the level of diversification an ETF offers, you would have to buy a large number of individual shares and take on the trading costs for each transaction.

Accessibility
ETFs can be bought or sold just like stocks, traded through any financial adviser, brokerage or internet account. Because ETFs are so flexible, institutional and private investors are using them in a whole range of investment strategies.

Caution

• The value of the investment involving exposure to foreign currencies can be affected by exchange rate movements. The levels and bases of, and reliefs from, taxation can change.
• Please note that income is not fixed and may fluctuate. Past performance will not necessarily be repeated and is no guarantee for future returns.
• The price of the investments may go up or down and you may not get back the amount invested.

Versatility
ETFs cover the investment landscape from all angles. You can invest in them by asset class, country, market capitalisation and style. With so many different choices, you can adopt a broad range of strategies, including:

Core-satellite investing
Using a core of lower risk investments, while seeking higher returns at the margin (satellite strategies).

Tactical asset allocation
Shifting between different asset classes (such as equities and bonds) as a reflection of economic events or in anticipation of a changing market.

Buy-and-hold
Used as part of a long-term investment strategy.

Best Features
ETFs capture the best features of both traditional funds and individual shares.

Control
With a wide range of funds, ETFs give you instant access to the world's investment markets. These funds allow you to obtain exposure to a specific index without having to pick individual stocks. This means you can invest in a highly diversified, cost-effective and risk-controlled way.
Simply put, ETFs are funds that behave like any other shares on a stock exchange. The only difference is that rather than representing the value of just one company, each ETF gives exposure to the companies in an entire index. The performance of the shares reflects the performance of the index, including dividend payments, minus the charges applied by the fund.

Providers

• Many European exchanges list various ETFs including: Borsa Italiana, Frankfurt Stock Exchange (Xetra), Euronext Amsterdam, Euronext Paris, London Stock Exchange, SWX Swiss Exchange and virt-x.
• Leading index providers, on whose indices ETFs are based, include FTSE, MSCI, STOXX, iBoxx and Standard and Poor's.
• Top market makers include ABN AMRO, Banca IMI, Barclays Capital, Bear Stearns, Credit Suisse, Deutsche Bank, Dresdner Kleinwort Wasserstein, Goldman Sachs, JP Morgan, Lehman Brothers, Merrill Lynch, Morgan Stanley, Susquehanna and UBS.

Strategy
Many institutional investors now see indexed and active investments working together. Their strategy is to build a low-risk, cost-effective core using a broad-based index fund, while pursuing higher returns with more aggressive active funds, or exotic index funds (satellites) and individual stock positions.

The advantage of this approach is that you can tailor the portfolio to meet very specific risk return requirements.
Before ETFs, the barrier to this working satisfactorily had been cost. Once an investor starts to use more than one or two investment funds, commissions can eat into profits.
ETFs minimise this problem. They are cost-effective. Total Expense Ratios (TERs) start as low as 0.2% so you can take positions in a range of funds without worrying about excessive management fees.

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