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Short Guide to Exchange Traded Funds

Short Guide to Exchange Traded Funds

Written by Tina Winter

ETFs are one of the fastest growing types of investment funds worldwide, and provide a low cost way to provide index tracking. They combine the advantages of an open ended capital structure (e.g. Unit Trust / OEIC) with the efficiencies of exchange traded instruments (e.g. equities).

Main features (see glossary for explanation of acronyms):

  • Set up as a company which will normally be a SICAV or OEIC.
  • Management Structure – often an ICVC
  • Regulatory authorisation in country where fund is domiciled
  • Indexation methodologies can by physical or synthetic

Physical replication will be by means of one or a combination of the techniques used in other index tracking funds, i.e. full replication, stratifies sampling or optimisation.

Synthetic replication will often be carried out using derivatives, particularly a swap – swapping the return on an index for a payment – these can be either funded or unfunded swaps. This means that responsibility for tracking the index is passed on to the counterparty, but also adds counterparty risk.

Pricing and valuation – ETFs value their portfolios daily and provide details of their NAV and number of shares in issue via RNS.

Dealing and Settlement – ETFs are listed and traded on stock exchanges, giving the ability to trade at any time – they trade at prices very close to the NAV. They have no initial fees and have a TER lower than similar index tracking funds, but there will be brokerage charges and Stamp Duty on UK funds.

ETFs are increasingly being used as the core funds in core-satellite portfolios and the market for them is likely to continue to grow.

Glossary of acronyms:

ETF – Exchange Traded Fund (sometimes called ETP or Exchange Traded Product)

OEIC – Open Ended Investment Company

SICAV – Société d’Investissement `a Capital Variable (French for OEIC, normally Luxembourg based)

ICVC – Investment Company with Variable Capital

NAV – Net Asset Value

RNS – Regulatory News Service

TER – Total Expense Ratio