| Exchange-traded Funds Investment Instruments | ||||||||||||
Hardly any other financial products were so successful in the past months as exchange-traded funds – among both professionals as well as private investors. Despite the current difficult market environment, this form of investment is recording unbroken growth in capital inflows, as well as a constant increase in providers and funds issued in Europe. Is this a trend which private investors should follow?  Topics
Exchange-traded funds – often termed simply by their abbreviation, ETFs – have been available in the United States since 1993. They have meantime become firmly established in the U.S. market. In Europe, turnover of around €5.2 billion was generated in exchange-traded fund shares in November 2004. Deutsche Börse’s XTF segment is the largest marketplace for exchange-traded funds in Germany. This is where investors can buy and sell funds as easily and inexpensively as shares. In November 2004, the XTF segment had a European market share of more than 50 percent. Inexpensive, flexible and transparent If one considers the advantages of exchange-traded funds, their success is hardly surprising. ETFs are often less expensive than classical fund products: Classical funds are usually sold with a front-end load at bank counters. On the exchange, the investor only pays the spread between the buying and the selling price, which is usually markedly lower than a front-end load. Since a price is only determined once a day – generally at midday – for classical funds, shares can also only be bought or sold at this one single price. Thus, fluctuations during the day are not taken into account. In addition, the investors seldom know the price at which their order was finally executed. If, for example, an investor decides to buy a classical fund in the afternoon, an order will not usually be executed until the next day at the midday price by most banks. This can lead to unpleasant surprises, especially in the case of volatile markets. Prices for exchange-traded funds, on the other hand, are determined every minute in continuous trading. Orders are executed immediately. One market maker per fund ensures the necessary liquidity in the XTF segment. These “Designated Sponsors,” as they are already known from stock trading, enter binding bid and ask prices. Their quotes are always close to the price calculated by the system. In addition, investors can specify more closely how and when their orders should be executed, since the Xetra trading order supplements can be used in the XTF segment. Thus, for example, investors have the option to set stop-loss prices for limit orders. Exchange-traded funds have one disadvantage: They are not suitable for trust savings plans, since small transaction fees are charged for each of the small payments that continually occur. Thus the classical products are more suitable to fund-based savers. Actively or passively managed? They aim to outperform the price development of the underlying index. The composition of the fund’s portfolio is reviewed and adjusted by the fund manager according to the market situation. The range of funds in the XTF segment is large and highly diversified. A basic differentiation is made between actively and passively managed funds. In the case of actively managed funds, the fund management company selects individual securities according to the fund profile. The result is assessed using an index which serves as a benchmark. This comparative index has to be “beaten.” Passively managed funds, on the other hand, reflect these indices. They are therefore termed “index funds.” The most noticeable difference for private investors is the cost. The expenses incurred by the issuing company are considerably higher for an actively managed fund – and likewise also the management fees which the investor must bear. In the case of index funds, management fees average 0.5 percent per year. The jury is out as to whether actively managed funds compensate for these additional costs with better performance. One often hears from branch insiders that over a five-year term, only a small few of the actively managed DAX funds performed better than the index itself. On the other hand, individual fund management companies such as DWS maintain that the majority of their products lie above the levels of the benchmark indices. Asset per Minute
Investors can now choose between 55 passively managed index funds and 24 actively managed funds. The number of issuers has meantime risen to seven banks and fund management companies. The passively managed funds in the XTF segment cover many large indices like the DAX, the FTSE or MSCI World. But also other, slightly more “exotic” markets are reflected: With the launch of the new Dow Jones STOXX 600 sectoral fund, trading can now be carried out in all 18 branches of the DJ STOXX family. Fixed-income funds are also tradable in the XTF segment. Private investors must note one thing: The large number of sectoral and regional funds on offer today are subject to more volatile trends. One should therefore watch them more closely. If investors do not want to do this themselves, then one of the actively managed funds in the XTF segment could be a more suitable instrument, despite the higher management fees. Investing in an exchange-traded fund in the XTF segment functions like investing in a share. The size and value of the shares are offered at a fraction of the index level: For example, if the DAX is at 4,000 points, you can purchase a DAXEX paper (an index fund which mirrors the DAX) for €40 (plus the provider’s spread, of course). One share is the minimum lot size for an order. Each fund in the XTF segment has a German securities identification number (WKN). Of course, as with shares too, you do not trade directly via Xetra, but rather let your bank, which is connected to Xetra, execute the order for you by specifying Xetra as the desired exchange for execution. |
