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ETF Essentials
Inside the ETF revolution
Jerome M
...
US – ETF Providers
ETF managers in Europe by AUM
Amundi ETF
3
...
30%

Swiss & Global
Asset
Management(J
ulius Baer)
2
...
00%

Van Eck
Associates
Corp
2
...
50%

Other
7
...
60%

iShares
40
...
70%

ETF
Securities
7
...
50%

Db xtrackers/db
ETC
13
...
As at Sept 28 2012
...
00%

ProShares
1
...
70%

UBS Global
Asset
Management/
UBS AG
4
...
90%

ETF managers in the US by AUM

State Street
Global
Advisors
24
...

•

They are listed and traded like a stock on major stock exchanges globally
Index Fund

Single Stock / Future

• Simplicity

• Trading flexibility on exchange

• Transparency

• Intraday pricing

• Risk control

• Listed options

• Cost control
• Consistency of returns
• Diversification

+

• Ability to borrow / short
• Any transaction size
• Variety of trading strategies

• Mutual Fund
• Open-End Fund

Exchange Traded Fund

ETFs occupy a unique position in the investment landscape: The intersection between and index fund and a listed security

Advantages of ETFs

Why are ETFs so popular?
Transparency

• Investors know the ETF holdings, price and costs

• ETFs offer two sources of liquidity:

Liquidity

• Traditional liquidity measured by secondary market trading volume
• Multi dealer model boosts the liquidity of iShares ETFs

Diversification

Flexibility

Cost
effectiveness

• ETFs provide immediate exposure to a basket or group of securities for instant diversification
• Broad range of asset classes including equities, bonds, commodities, investment themes, etc

• ETFs are listed on exchanges and can be traded at any time the market is open

• Pricing is continuous throughout the day

• ETFs offer a cost-effective route to diversified market exposure

Physical Based ETFs
Example for Illustrative Purposes : iShares FTSE 100 Physical based ETF

Portfolio
Managers
purchase stocks
to represent the
index

Source: iShares website as at 17/09/12 and is for illustrative purposes only

Exchange
Traded Fund

Equity Market Volatility: Days with market move of
more than 2%
For professional clients / qualified investors only

Source: Bloomberg as at 18/09/12

Diversification with ETFs
Equities

Fixed Income

Alternatives

Cash & Cash
Alternatives

Commodities

World

UK Gilts

Property

Short Term
Treasuries

Broad

Developed Markets

International
Government

Private Equity

Precious Metals

Emerging Markets

Index-Linked Gilts

Global Water

Commodity
Producers

Large, Mid, Smallcap

Corporate

Growth Value

Covered

UK Equity

ETF Structures

Structure
• Different types of ETPs imply different levels of complexity and carry different structural
risks
...


Exchange Traded Products (ETPs)

Exchange Traded Funds (ETFs)
• Physically replicating ETFs:
– Fully replicating

– Optimised/partially replicating
• Derivative replicating ETFs

Exchanged Traded Notes
(ETNs)/Exchanged Traded
Commodities (ETCs)

Exchange Traded
Instruments (ETIs)

Structure Prioritisation
Can this product
idea comply with
UCITS?

Compliance with the European Union UCITS Directive is critical to market funds from one EU
country in other EU countries and UCITS demonstrates independent oversight and
diversification
Vehicle Choice

Non-UCITS

UCITS

Can we run it as a
normal fund?

Physical ETF

If not physical fund,
Derivative
will swaps be
replicating ETF
possible?

Comments

Fund holding physical securities

Fund holding swaps

Can this asset be
practically stored?

Physical
Exchange
Traded Commodity

Note backed by the physical asset

Will an institution
guarantee the
return?

Exchange
Traded Note

Note backed by an institution’s credit

Physical-based ETFs
Two types: replicated and optimised
 Replicated

 For example:
 iShares FTSE 100
 iShares EURO STOXX 50
 iShares S&P 500

 Optimised

 For example:
 iShares MSCI World
 iShares Barclays Capital Euro
Aggregate Bond
 iShares MSCI Emerging
Markets

Source: BlackRock
...


Swap-based ETF

 Key features:

 Ability to construct UCITS compliant
ETFs which are impossible to create
with the physical structure
 Full transparency (collateral, swap
counterparties, swap exposure etc)
 Good quality, UCITS-compliance
collateral with an extra margin
 Diversified counterparty exposure
 They are still not physical-based ETFs

Multiple counterparties and over collateralised swap exposure?
Source: BlackRock
...


Exchange Traded Commodities

• iShares defines ETCs as debt securities that are backed by fully-allocated physical holdings of precious
metals held in secured vaults
• Many ETCs are eligible for investment by UCITS but are not themselves units in a collective investment
scheme as defined by the UCITS directive
For professional clients / qualified investors only
• iShares ETCs’ assets are held in ring-fenced segregated accounts
• ETCs are typically backed by metal held in secured vaults

ETF Trading and
Total Cost of Ownership

How traditional mutual funds work

Buyers
Mutual Fund

Stock
Exchange

Sellers

Investors interact with the fund to buy or sell shares

22

ETFs work differently than traditional mutual funds

Buyers
Stock
Exchange

“Authorized
participants”

Sellers

• Investors buy and sell on an exchange and
are insulated from each other’s actions
...


Trading and Liquidity
•

iShares Capital Markets Group can assist clients with accessing each layer of liquidity
...


25

Total Cost of Ownership
Passive Market Growth = More Passive Providers

New Providers = More Competition

New Providers More Competition = Lower TERs

= More Competition
Lower TER

=

Lower Total Costs

Total Cost of Ownership
The true cost of owning an ETF
• Total Cost of Ownership:
– Is NOT just TER
...

Internal factors

Physical
replicating
funds

Derivative
replicating
funds

External factors

• Total Expense Ratio (TER)
...


• Trading spreads
...


• Total Expense Ratio (TER)
...


+

• Creation/redemption
...


=

Total
Cost of
Ownership

• Tax
...


• BlackRock believes Total Cost of Ownership is an accurate measure of investing in
an ETF
...
TER – A Selection of iShares ETFs
Total Expense Ratio vs
...
Data as at end of March 2012
...
Evaluate the ETP provider

2
...
Evaluate the product structure

Physically
replicating ETF

Derivative
replicating ETF

ETCs or ETNs

4
...
active funds

Manage risk
Diversification
Tradability and
flexibility

Express a view

Transparency

Spend less,
save more
Cost
effectiveness
Tax efficiency

Practical uses of ETFs

Core satellite
Portfolio construction/ Diversification

Interim beta/ Transition management
Cash equitisation
Delta 1 alternative

Risk management
Portfolio construction/Diversification
Sectors and exotic markets

Implementing Core / Satellite Strategies
Core - passively managed vehicles, such as ETFs or
traditional index pooled funds lend themselves ideally to
the core component of an investment portfolio due to four
main reasons:
•
•
•
•

Broad diversification by closely mirroring asset
class benchmarks
Consistent performance relative to a benchmark
Low costs
Improved risk management

ETFs
Active
Strategy 1

Active
Strategy 3

Active
Strategy 2

Satellites - are typically more specialised investments
which serve as active tools to deliver additional returns
(alpha)
...

Exposure to selected market segments at low
costs
Eliminating security selection or manager
selection risk

Portfolio
ETF
Satellite

ETF
Satellite

ETF
Satellite

Strategic and tactical
Tactical Model Portfolio

Hong Kong

• Strategic Model Portfolio

Switzerland

Japan

Taiwan

Colombia
Egypt
Malaysia Chile
Brazil
China
India
Korea
Czech
Republic

Israel

Russia

Thailand
USA

Thematic Model Portfolio

For illustration purposes only

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