ETFs – exchange-traded index funds

ETFs - short for Exchange Traded Funds - have been more successful than almost any other financial innovation worldwide in recent years, both among institutional and private investors. Nevertheless, surveys show that many investors in Germany are unaware of this form of investment and use it even less. In view of the advantages of this form of exchange-traded fund over other investments, some opportunities lie fallow here. 

In the USA, ETFs have been firmly established there since 1993. In Germany, the first index trackers were only listed on the stock exchange in 2000 - with great success, as monthly turnover is now around 14 billion euros (as of 2014).

Passive instead of active?

ETFs represent the portfolio of a pre-determined index. Unlike actively managed mutual funds, there is no single stock selection. In the latter case, the fund management tries to generate above-average returns through targeted individual security selection. The yardstick is usually a benchmark index. 

The special thing about an ETF

ETFs must meet two additional criteria:

• The composition of the portfolio of ETFs is published on a daily basis. This gives investors a continuous overview of the weighting of the individual shares in the portfolio on the basis of the closing prices of the previous day.

• ETFs have a so-called creation/redemption mechanism which allows professional market participants to exchange baskets of shares corresponding to the index composition for ETFs (and vice versa) with the fund company at any time.
  In other European countries, the name ETF is only used for such funds, even if a direct translation of Exchange Traded Funds into German would suggest that this generally refers to exchange-traded funds.

The name ETF is only used for such funds in other European countries, even if a direct translation of Exchange Traded Funds into German would suggest that this generally refers to exchange-traded funds.

iNAVs for exchange-traded funds

The value of a fund unit is calculated by dividing the fund assets by the number of unit certificates outstanding. If the value of the investments contained in the fund assets increases, the fund assets or the value of the unit certificate will also increase.

Certificates are issued for the individual units in an investment fund, certifying co-ownership of the fund assets to the holder and guaranteeing a claim to profit participation and unit redemption at the applicable redemption price. The exact legal provisions governing investment funds can be found in the German Investment Code (KAGB).

In a classic fund, the fund company calculates the total fund assets - the official net asset value - once a day, in rare cases even once a week. This, in turn, determines the fixed buying and selling price of a fund unit, which is then set only once a day.

For exchange-traded funds, either Deutsche Börse or alternatively a service provider commissioned by the issuer calculates the "indicative net asset value", iNAV® for short, at least once per minute during trading hours. As a rule, the fund assets are determined on the basis of the prices of the individual positions in the fund portfolio and the cash resources of the fund are added. The fund assets calculated in this way divided by the number of fund units in circulation result in the iNAV value, which Deutsche Börse publishes every minute like a share price.

The biggest difference noticeable to private investors is in costs. The expense that the issuing company has to incur is considerably higher with an actively managed fund - consequently also the management fees that investors pay. Management fees for index funds average less than 0.4 percent annually, and 1.5 percent for actively managed mutual funds. Opinions differ as to whether actively managed funds can compensate for these additional costs with better performance.

Especially in very transparent markets, such as German blue chips in the DAX or US stocks in the S&P500, only a few actively managed funds manage to outperform ETFs over a five-year period.

• A good overview of the performance comparison between active and passive is provided by SPIVA, a dynamic comparison of funds with their benchmark for different markets and periods on us.spindices.com.

Please choose!

The range of exchange-traded funds is growing continuously. The ETFs cover all major indices such as the DAX, FTSE and MSCI World. But also other, somewhat more "exotic" markets are mirrored: For example, ETFs on the S&P GSCI allow index-linked investment in commodities, while some providers offer a sector fund for each Euro Stoxx sector. There are now a number of ETFs that pursue fundamental and quantitative strategies and a steadily growing universe of bond ETFs. New, very strong trends are ETFs whose composition includes sustainability criteria.

Active ETFs

A special form of ETFs are actively managed ETFs - Active ETFs for short. Although a management makes active decisions with this type of product, what distinguishes them from actively managed mutual funds is that, like ETFs, they offer a high degree of transparency and can be traded via Xetra with several designated sponsors.

Juni 2019, © Deutsche Börse AG