INDEX INVESTING EXCHANGE-TRADED PRODUCTS
“
ETCs, unlike ETFs,
do not follow a fund
structure and are
therefore unlikely to
fall under the remit of
the FSA compensation
scheme should there
be a major difficulty.
ETCs cannot therefore
be Ucits compliant, as
they are not funds
”
2009 was $1,032bn, up
45% from a year earlier.
The US continued to lead
the way in ETFs, with
assets totalling $705bn at
the end of 2009, up 42%
from a year earlier. Europe
continued to grow at a
faster pace, with assets
rising nearly 57% to
$223.5bn over the year.
Of the three product
categories, ETFs offer
investors the best legal
protection as they follow a
mutual fund structure. UK
listed ETFs are almost
always subject to the investor
protections and regulations
of Ucits with regular
accounts and reports, and
the portfolio being mutually
owned by investors,
rather than the product
provider.
ETFs cover many well
known indices and
exchanges, but as the ETF
market place has grown,
many non-traditional ETFs
have been created.
While the popularity of
ETFs grew on the beneficial
characteristics of being low
cost – following large broad
indices and being transparent
– the recent explosion
in listings has led to many
ETFs which do not offer
these characteristics in full.
Instead, they may be leveraged,
short, follow a complicated
quant selection or
follow a small and volatile
sector or market.
l Liquidity of ETFs
Exceptional
Value.
With so many new ETFs
and providers coming to
the market every week, as
well as understanding
exactly what makes up the
underlying index, it is vital
to look at the liquidity of
the particular ETF in terms
of the bid/offer spread.
This will be determined
partly by the liquidity of
the underlying index (an
ETF following the FTSE
100 is likely to have a
smaller spread than an
emerging market small
companies ETF) but also
by the size of the ETF and
the daily stock market
volume in that particular
ETF.
For example, if you
wanted to buy a spread of
US healthcare stocks, you
could buy the Source Health
S&P US ETF; and if you
wanted to buy a spread of
European healthcare stocks,
you could buy the X-
Trackers DJ STOXX 600
healthcare ETF.
Looking at the spreads
of the two ETFs (both listed
on the London Stock
Exchange) reveals a bid/
offer spread at the time of
writing of 3.9% for the US
ETF against 0.3% for the
European ETF. This is no
doubt due mainly to the
fact that the US ETF has a
size of £0.1m versus £83.3m
for the European ETF, but it
reveals that potential investors
always need to look
carefully under the bonnet
before buying any ETF.
l Single commodities
The second type of
exchange-traded product is
an ETC, which invests in a
single commodity or group
of commodities such as
precious metals or energy,
and does not offer the
same diversification as
an ETF.
Some single commodity
ETCs follow the spot price
of a commodity, but most
ETCs implement a futures
trading strategy, which may
produce very different
returns from owning the
underlying asset.
ETCs, unlike ETFs, do
not follow a fund structure
and are therefore unlikely
to fall under the remit of
the FSA compensation
scheme should there be a
major difficulty. ETCs
cannot therefore be Ucits
compliant, as they are not
funds. In addition, ETCs
often represent exposure to
a single commodity or commodity
group, and so would
not comply with the diversification
rules. In terms of
diversification risk, ETCs
tend to be single product
and therefore much more
volatile than more diversified
commodity ETFs.
l Diversification
Historically few investors
ever invested in commodities,
but recent substantial
and almost unprecedented
price gains have led to
investors piling into commodities
generally and
single commodities in particular.
This has normally
been via ETCs as these tend
We believe costs count. Which is why the Annual
Management Charges (AMC) for our funds – ranging from
0.15% to 0.55% – are among the lowest in their class.
And, as we pay all running costs out of our AMC, we expect
our Total Expense Ratio (TER) to be the same as our AMC, so
investors know the exact cost to their investment. It’s just one
of the ways we provide value to your clients.
Exceptional Value. It’s the Vanguard Way. ™
0800 917 5508 vanguard.co.uk
This advertisement is directed at investment professionals in the UK only and should not be distributed to, or relied upon by retail investors. It is designed only for use by, and is directed only at
persons resident in, the UK. Vanguard Investments UK, Limited only gives information on products and services and does not give investment advice based on individual circumstances. The value of investments,
and the income from them, may fall or rise and investors may get back less than they invested. Issued by Vanguard Investments UK, Limited which is authorised and regulated in the UK by the Financial Services
Authority. © 2010 Vanguard Investments UK, Limited. All rights reserved. UK10/0149/0410
54 PORTFOLIO ADVISER [www.portfolio-adviser.com] MARCH 2010
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