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Created on 02.08.2018

ETFs – trading on the stock exchange with funds

ETFs are investment funds traded on the stock exchange. They have become increasingly popular with investors in recent years. They are appealing because they are transparent, affordable, well diversified and flexible while combining the benefits of shares and funds in a single product.

An ETF reflects the performance of the underlying index – for example, the SMI. In contrast to traditional index funds, ETFs are traded on the stock exchange. An ETF does not generally seek to outperform the market either – in complete contrast to traditional funds. An overview of other ETF characteristics:

Low costs

There are no research costs with passively managed ETFs which simply track an index. This is why they are less expensive than actively managed funds. Nor do ETFs incur any additional costs, such as issuing or redemption commission. However, in contrast to funds, stamp duties and brokerage fees are charged.

High degree of transparency

ETFs are traded on the stock exchange – this means all stock exchange information required can be accessed transparently at all times. Investors can also view the exact composition of their ETF on a daily basis. The ETF providers publish the updated basket of securities every day. You can also find much of this information about funds. However, all of the information required for ETFs is published on a much more regular basis.

High degree of diversification

By investing in an ETF, you gain access to an entire market with just one transaction. This means you benefit from well-distributed risk and low transaction costs.

High degree of liquidity

In contrast to funds, ETFs can be traded at any time during normal stock market opening hours. They can be bought and sold continuously thanks to so-called market makers. Another special characteristic is the creation/redemption process. This means the number of ETF units can be increased or reduced depending on demand without affecting other fund unit holders. If demand for a specific ETF rises, new units can be created in exchange for underlying securities to meet the demand. If demand falls, the number of shares can be reduced by exchanging fund units back for securities.

Physical versus synthetic

A distinction is made between physical and synthetic ETFs. In the case of physical ETFs, all securities of the underlying index are purchased and weighted in the same way as the relevant stock market barometer. Synthetic ETFs do not track the index directly, but instead through what are known as swap transactions with banks.

Risks

As with other securities, exchange-traded funds are also exposed to general market and exchange rate risks. As ETFs track an index, they perform almost identically to the underlying stock-exchange barometer. If political or social developments have a major impact on the economy and financial markets, this will also affect your ETF. The default risk of the additional third party also comes into play with synthetic ETFs. There are also complex products on the ETF market, such as leveraged ETFs or smart beta ETFs which are less transparent.

ETFs are exciting alternatives to traditional, actively managed funds. They are suitable for any portfolio and ideal for new investors. A vast range of products exists.

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