db X-trackers ETFs A 10 Step Guide to Exchange Traded Funds

Transcription

1 Deutsche Bank db X-trackers Marketing material db x-trackers Simply buy the market db X-trackers ETFs A 10 Step Guide to Exchange Traded Funds

2 Contents 3 Introduction 4 Step 1 What are ETFs? 5 Step 2 How do ETFs work? 6 Step 3 How can I invest in ETFs and what are the costs? 7 Step 4 What types of ETFs are available? 8 Step 5 Pricing efficiency and liquidity of ETFs Step 6 Understanding synthetic market tracking 9 Step 7 Understanding the risks of ETFs 10 Step 8 The use of collateral to offset counterparty risk exposure 11 Step 9 Taxation and ETFs 12 Step 10 The differences between ETPs, ETCs, ETFs and ETNs 13 Investment risks relating to db X-trackers ETFs 14 About db X-trackers ETFs 15 Important Information 16 Further Product Information 2 Contents

3 Introduction Exchange Traded Funds (ETFs) are becoming increasingly popular thanks to their low fees, accessibility, flexibility, diversity, transparency and liquidity. Investors with existing holdings in investment funds or pension funds may well find that those investment vehicles are already using ETFs to some extent. Investors and financial advisers may now, however, wish to look at how ETFs can be invested in directly. This 10-step guide from db X-trackers, Deutsche Bank s ETF platform, is designed as a plain language introduction to the world of ETFs, covering the possible benefits, risks and uses of ETFs for all investors, and showing how investors can simply buy the market. Please note that in conjunction with reading this guide, potential investors should also read the relevant prospectus and/or key investor information document (KIID) available on individual ETFs. Before investing, investors should also engage with their financial advisor so as to ensure they understand the characteristics, investment strategy and risks of a particular ETF. The ETF market is now sufficiently broad in scope such that, whatever the area or market sector an investor may be interested in, there is likely to already be an ETF available to suit their needs. Indeed, there may be many other ETFs that investors may not yet have considered that could help reshape a portfolio. It is important however to always take into consideration that some ETFs are only appropriate for sophisticated investors. This guide does not constitute investment advice as explained more fully in the disclaimer on page 15 of this guide. For further information on risks please see Steps 7, 8 and page 13. Introduction, Step 1 3

4 Step 1 What are ETFs? ETFs are funds that trade on an exchange as a single security, and which usually aim to provide exposure to the components of an index. They combine in a single product the tradability and liquidity advantages of stocks with the low costs and diversification benefits of index funds. Most ETFs listed in Europe and all db X-trackers ETFs comply with the UCITS (Undertakings for Collective Investment in Transferable Securities) regulations. ETFs could therefore be considered a straightforward way for an investor to potentially gain instant exposure to a particular market, region, sector, asset class or investment strategy via a single transaction. If an investor wishes to rebalance part of their portfolio towards the US, the Far East, European small companies, telecoms, natural resources, fixed interest, healthcare, utilities (the list is extensive), then they can simply buy the market they want, when they want, through an ETF. Most ETFs can be held in an ISA or SIPP and most are also regulated as authorised open-ended investment funds, yet with the key additional advantage that they can be traded intra-day (throughout the trading day) on the stock exchange in the same way as any other listed, tradable security. One of the most cost effective ways to invest Typically UCITS compliant when listed in Europe Instant market access at low cost Trade intra-day 4 Step 1

5 Step 2 How do ETFs work? ETFs are structured as open-ended investment funds and can be traded intra-day on various stock exchanges, including the London Stock Exchange ( LSE ). Most ETFs are passive investments and are not actively managed by a fund manager. The aim of these passively managed ETFs is to mirror or replicate an index that represents a particular market, such as the UK FTSE All Share, or a specific sector such as the DJ STOXX 600 Banks (an index which represents the largest European companies in the banking sector). There are a wide variety of indices in existence today and more are being created that allow products like ETFs to track the aggregate value of all the companies or securities that make up a particular index. There are two methods used by ETFs to track the performance of an index. The first method typically involves directly investing in some or all of the components of the relevant index in order to track the performance of that index. With the direct investment method the performance of the ETF reflects the returns of the components comprising the index less fees and replication costs. The direct replication method may be subject to tracking differences due to the practicalities of managing the index components. When only a portion of the underlying index is held physically this is called sampling, or optimized sampling. Sampling relies on mathematical models to build a portfolio consisting of a smaller number of securities than the broader basket the portfolio is tracking. The accuracy of the tracking when sampling therefore is model dependent. The second method involves replicating the index performance synthetically via an over the counter (OTC) index swap transaction with a counterparty such as an investment bank. This provides precise replication of the index performance less fees and any replication costs. Both tracking methods are used by leading ETF providers in Europe. In the case of db X-trackers most of the db X-trackers ETFs track indices through synthetic replication, with Deutsche Bank as the counterparty. The returns of ETFs include income distributions which are either paid out at regular intervals or automatically reinvested, and therefore reflected in the level of the index that the ETF is tracking, which means ETF holders do not miss out on dividend payments. Exposure to an index through a regulated UCITS fund Dividends included in the returns of an ETF Synthetic replication ETFs can provide very good tracking of an index before fees plus any replication costs Step 2 5

6 Step 3 How can I invest in ETFs and what are the costs? ETF shares can be traded through a broker or via a fund or wrap platform a service offered by investment companies offering a portfolio of ETFs or other online dealing services. They trade and settle through stock exchanges and clearing systems in the same way as any other listed, tradable security, with no set-up documentation or specific trading process required. Unlike an active mutual fund, where the investor is paying an extra layer of fees for a fund manager to select stocks with the aim of outperforming an index or benchmark, an ETF is a passive fund that just tracks the underlying index, without the additional costs associated with active fund management. It is also worth noting that most mutual funds will deal only once a day at a forward point, on either the same or the following day from when the investor deals, and also at an unknown valuation from the time the order was placed. ETFs however can be traded at any time during stock exchange trading hours and at any size at the price the investor sees and agrees to. Annual management fees and running costs for ETFs are extremely competitive and are known as the All In Fee. These are capped at a maximum level. For example, the annual All In Fee for the db X-trackers FTSE 100 ETF is 0.30 %. There are no upfront or exit fees for ETFs and there is also no stamp duty on buying ETFs on the LSE. (There may be other fees and commissions payable. Please consult your financial advisor regarding any additional fees for which you may be liable.) Buy or sell through your broker, platform or dealing service Trade and settle the same as any stock exchange-listed security Low All-in Fees, no stamp duty on LSE-listed ETFs, and no up-front or exit fees Impact of fees on long term Performance With long-term investments the fee structure has a significant impact on an investment s performance. Take for example a one-off investment of 20,000 with an annual return of 8 % p.a. for 20 years. Assuming a management fee of 1.5 % p.a. this would return a final sum of 70,472.90, while with a lower management fee of 0.5 % p.a. the final sum would be 84,957.02; over 14,000 more just from a lower fee structure! 6 Step 3

7 Step 4 What types of ETFs are available? On the LSE there are over 500 ETFs available (incorporating db X-trackers offerings and the ETFs from other providers), including many providing exposure to markets that were previously difficult to access or beyond the scope and means of many investors. Now, through the simplicity and efficiency of ETFs, investors can access: 1. Developed markets UK, USA, Europe, Japan, world 2. Emerging markets regional and individual countries, e.g., India, China and Brazil 3. Different investment styles value/growth, small/mid cap, high dividends 4. Fixed Income government and corporate bond 5. Sectors gain exposure to sectors such as healthcare and banks on a pan European, global developed and global emerging markets basis 6. Money market track overnight money market rates for major currencies (Euro, US Dollar, Sterling) 7. Commodities 1 diversified indices covering a wide range of commodities 8. Investment themes and sectors e.g. infrastructure, private equity, Shariah 9. Alternative investments hedge fund indices 10. Daily short and daily leveraged index ETFs for financially sophisticated investors who want to use ETFs as a short term trading tool, e.g to hedge their portfolio or take contrarian views As ETFs are becoming ever more specific in the areas they cover, investors and advisers can now be very precise in their portfolio construction and asset allocation. ETFs provide access to mainstream areas as well as those only previously available to specialised investors The ETF market continues to expand to provide investors with more granular and different types of exposures 1 Investors should note that commodity ETFs provide exposure to broad commodity indices only. There are other exchange traded products, called ETCs (Exchange Traded Commodities), which provide exposure to single commodities such as gold. See Step 10 for a definition of ETCs. Step 4 7

8 Step 5 Pricing efficiency and liquidity of ETFs A feature of the efficiency that ETFs offer is that under normal market conditions the price of an ETF will generally be kept close to its net asset value by authorised market making firms, which correct any premium or discount that may occur in the price during trading on an exchange. The market making firms attempt to correct supply and demand imbalances that can cause the price of the ETF to trade at a premium or discount to the net asset value (note that premiums or discounts to NAV can occur, and may typically last for a short period of time before trading by market makers corrects the anomaly; liqudity may not always be present in ETF markets). This has advantages for both large and small investors as it means trades could be made in any size. The pricing of ETFs therefore tends to be both efficient and transparent. Many ETFs publish an inav or Indicative Net Asset Value, which is calculated and updated to reflect real time movements of the index being tracked. In most cases the bid/offer quotes for an ETF share on the stock exchange will move in line with its inav. Transparent, continuous and efficient intra-day pricing on the stock exchange (liquidity depends on market conditions) Instant access and no premiums/discounts to fair value Flexible easy to trade in small and large sizes, typically without market impact Step 6 Understanding synthetic market tracking As stated earlier in this guide, there are two basic ways in which ETF providers can construct products for the purposes of trying to track indices. The traditional method involves buying and holding the physical underlying securities of the index being tracked. However, this method is constrained in terms of the types of underlying indices that can be tracked, and in some cases can be prone to tracking difference transaction costs relating to index turnover for periodic index rebalancing and corporate actions can impact tracking performance, for instance. With synthetic replication ETFs, the swap counterparty agrees to deliver the returns on the index, which means the investor receives the precise returns of the index minus the all-in fee plus any index replication costs, if relevant. Another benefit of the synthetic or precision replication method is that it allows for the tracking of indices in difficult to access markets, such as some emerging markets, for example. Finally, by outsourcing the indexing provision to a group best placed to handle it a major financial institution such as Deutsche Bank efficiency gains can be had which, in the highly competitive ETF market ultimately get passed down to the end investor. Synthetic replication ETFs seek to provide investors with the most accurate index tracking available Synthetic replication ETFs can provide access to certain market indices that physical replication ETFs could not track 8 Step 5, Step 6

9 Step 7 Understanding the risks of ETFs Very few, if any, investments today can be truly thought of as risk-free, and ETFs are no different. ETFs are designed to track an index closely, both up and down in value, so investors should have an appreciation of market risk when buying an ETF. ETFs also expose investors to counterparty risk. In the case of synthetic replication ETFs, this comes from the bank providing the swap agreement. In the case of physically backed ETFs, this typically comes from securities lending (see Step 8). However, an ETF (such as the db X-trackers ETF range) or any other mutual fund that is structured under the Europe-wide UCITS (Undertaking for Collective Investments in Transferable Securities) regulations is subject to various diversification requirements and limits on counterparty risk exposure. These regulations apply to both methods of index replication, covering portfolio diversification requirements and limits on counterparty exposure in relation to securities lending activities and OTC derivative transactions. Some ETF providers, such as db X-trackers, seek to minimize this risk even further by setting strict limits on OTC derivative counterparty exposure (see next step). The investment risks relating to db X-trackers ETFs are outlined on page 13. Investors in ETFs must have an appreciation of market risk Counterparty risk is also present in synthetic ETF investments, and may be present in physically-backed ETFs (see Step 8) UCITS regulations limit counterparty risk in ETFs, while some providers such as db X-trackers seek to minimize this risk further There are specified limits on counterparty exposure for the synthetic or precision replication type of ETFs like db X-trackers. Under the UCITS regulations, the maximum exposure to an OTC derivative counterparty is 10 % of the Net Asset Value (NAV) of the fund. The reason for such a requirement is to try to ensure that if the counterparty becomes insolvent then losses to the fund are reduced (ideally to no more than 10 % of the fund s current NAV). However, this does not necessarily mean an investor will get back 90 % of the amount originally invested. The amount received would depend on the performance of the underlying index, which may have fallen over the period of investment and, in the case of synthetic replication ETFs, would depend on the value of the collateral posted to the fund which will differ from the underlying index being tracked. Step 6 9

10 Step 8 The use of collateral to offset counterparty risk exposure Investors in any fund investment product will generally be exposed to some form of counterparty risk. Traditional mutual fund providers and physically-backed ETF providers typically engage in securities lending, for example. This involves lending purchased securities in order to increase profits and returns, thereby creating counterparty risk to the borrowers of those securities. Because there is no requirement for details on securities lending activities to be disclosed at regular intervals, it can be difficult for investors in physically-backed ETFs and traditional mutual funds to measure or intuitively grasp the counterparty risk they are exposed to. To limit this counterparty risk, funds that engage in securities lending generally enter into collateral agreements, whereby collateral is posted to secure the arrangement which means if the borrower defaults then the lender retains the collateral as compensation. In the case of db X-trackers, db X-trackers ETFs do not engage in securities lending, so investors are not exposed to counterparty risk in this respect. However, with db X-trackers ETFs the swap agreements that exist between the ETF and Deutsche Bank AG creates counterparty risk for the ETF to Deutsche Bank AG. As with securities lending arrangements, this counterparty risk must be kept within appropriate limits by, for example, the counterparty posting collateral. As stated in Step 7, regulatory rules limit the counterparty risk in UCITS-compliant ETFs to 10 % of current NAV. However, db X-trackers limits this exposure to 5 % for its fixed income ETFs. For most of its equity, commodity and currency ETFs, a type of swap agreement known as a fully-funded swap ensures the ETF has no uncollateralized derivatives exposure. db X-trackers publishes swap exposures and collateral basket compositions for all of its ETFs on its website ( This information is updated daily and provides a full breakdown of underlying collateral positions, even to the individual security level. Investors throughout the fund industry may be exposed to counterparty risks Although db X-trackers ETFs do not engage in securities lending, counterparty risk results from the use of swap arrangements. Such counterparty risk is kept within certain limits by, for example, posting collateral Any interested party can access daily updated information on swap exposures and collateral basket securities from the db X-trackers website The below is an example of how this information is presented on the db X-trackers website. 10 Step 8

11 Step 9 Taxation and ETFs ETFs could be used by a wide variety of investors and could form part of an Individual Savings Account (ISA) or pension through a self invested pension plan ( SIPP ). Outside of these tax wrappers they can still be used for tax planning, as many ETFs listed on the LSE are registered as Reporting Funds with Her Majesty s Revenue and Customs (HMRC). All db X-trackers ETFs are compliant with the Reporting Fund rules. What this means for UK individual investors is: (i) Any distributed income or reported income will be subject to income tax. If an investor is in any doubt about the taxation of db X-trackers ETFs then they should in all cases consult a financial adviser before investing. As mentioned in Step 4, there is no stamp duty when buying ETFs listed and trading on the LSE. ETFs can be held in an ISA or SIPP ETFs are compliant with Reporting Fund rules Investors with questions on the taxation of ETFs should contact their financial adviser (ii) Any gains made on the disposal of units/shares of an ETF will be subject to capital gains tax. Step 9 11

12 Step 10 The differences between ETPs, ETCs, ETFs and ETNs A number of three-letter acronyms have emerged in recent years as market tracker investment products have proliferated. Exchange-traded products (ETPs) is an umbrella term that typically refers to secured (meaning backed by assets), exchange-traded equity or debt instruments. Exchange-traded funds (ETFs) and exchange-traded commodities (ETCs) typically fall into this category. The other index tracking product to be aware of is exchange-traded notes (ETNs), which are typically unsecured debt instruments. ETNs are issued by banks as direct funding instruments, which means investors in ETNs bear counterparty credit risk to the issuing bank. In terms of risks, the different types of products come with different levels of counterparty risk. ETFs and ETCs minimise counterparty risk, either through the holding of physical assets or by posting collateral with an independent third party. ETNs, on the other hand, typically come with full counterparty risk to the issuing institution. The following illustrates the differences between the instruments. Stock Exchange Exchange Traded Products (ETPs) Secured/Collateralised (Backed by assets) Other Products Unsecured ETFs Exchange Traded Funds UCITS compliant OTC counterparty exposure limited to 10 % ETCs Exchange Traded Commodities Single commodity or diversified basket of commodities Futures or physicaly backed Secured/collateralised ETNs Exchange Traded Notes Single asset or diversified basket of securities Unsecured/uncollateralised Issuer credit risk A number of three-letter acronyms have emerged to describe listed investment products It is important that investors know the difference between ETFs and other listed investment instruments Risk profiles of each product category differ Definitions Exchange Traded Products (ETP) Securities that trade on exchanges, with ETPs being an umbrella term to describe ETCs and ETFs. Exchange Traded Fund (ETF) A type of ETP that is structured and regulated as a mutual fund. In Europe most ETFs comply with the UCITS regulations. Exchange Traded Commodities (ETC) A type of ETP that trades and settles like an ETF but which is structured as a debt instrument. Exchange Traded Notes (ETN) An exchange-traded structured note investment which is not collateralized. ETNs are debt instruments issued by a financial institution, which means holders are exposed to issuer credit risk. 12 Step 10

13 Investment risks relating to db X-trackers ETFs Investment in db X-trackers ETFs involve numerous risks including among others, general market risks relating to the relevant index, credit risks on the provider of index swaps utilised in the db X-trackers ETFs, exchange rate risks, interest rate risks, inflationary risks, liquidity risks and legal and regulatory risks. The db X-trackers ETFs use Deutsche Bank as the counterparty for OTC derivative transactions. In the event of a default under the terms of the OTC derivative transaction by Deutsche Bank, the db X-trackers ETFs would be liquidated, which means an investor could lose all or a significant proportion of their original investment. The NAV at the time of default may be considerably less than the amount an investor originally invested depending on the performance of the relevant underlying index. Investors should therefore understand and evaluate the counterparty credit risk prior to making any investment (Please refer to Steps 7 and 8). The value of an investment in a db X-trackers ETF may go down as well as up and past performance is not an indicator or a guarantee of future performance. db X-trackers may trade in limited markets. db X-trackers may be unable to track precisely the performance of an index. Investors income is not fixed and may fluctuate. Tax treatment of the db X-trackers ETFs depends on the individual circumstances of each investor. The levels and bases of, and any applicable relief from, taxation can change. For further information regarding risk factors, please refer to the risk factors section of the listing particulars or full prospectus. Investors should note that the db X-trackers ETFs are neither capital protected nor guaranteed. Investors could lose part or all of their investment. An investment in a db X-trackers ETF tracking a daily leveraged or daily short index is intended for financially sophisticated investors who wish to take a very short term view on the underlying index, e.g., for day trading purposes. Therefore the db X-trackers ETFs on leveraged or short indices are appropriate only for financially sophisticated investors who understand the strategy, characteristics and risks. The db X-trackers ETFs on leveraged or short indices are not intended to be a buy and hold investment. Please refer to the db X-trackers full prospectus and any relevant product annex for more information on db X-trackers ETFs. These documents are available free of charge from Deutsche Bank (see contact details on the back cover). The value of any investment involving exposure to foreign currencies can be affected by exchange rate movements. ETF shares may be denominated in a currency different to that of the traded currency on the stock exchange in which case exchange rate fluctuations may have an adverse effect on the returns of the fund. xx 13

14 About db X-trackers ETFs db X-trackers is Deutsche Bank s Exchange Traded Funds (ETFs) index tracking solution platform. db X-trackers was launched in January 2007 and is one of the fastest growing ETF providers in Europe. With 36 billion of assets under management (as at June 2011) db X-trackers is one of the three largest ETF providers in Europe. db X-trackers ETFs are listed on nine different exchanges across Europe and Asia and are supported by multiple market makers. On the London Stock Exchange, db X-trackers offers over 120 equity, fixed income, credit, money markets, currencies, commodities and alternative investment ETFs; providing all types of investors with the opportunity to invest in a highly transparent, flexible and efficient way. db X-trackers ETFs are domiciled in Luxembourg and comply with UCITS regulations. All of the above data was correct as at August Sobre los ETFs de db x-trackers

15 Important Information This document is intended for discussion purposes only and does not create any legally binding obligations on the part of Deutsche Bank AG and/or its affiliates ( DB ). Without limitation, this document does not constitute an offer, an invitation to offer or a recommendation to enter into any transaction. When making an investment decision, you should rely solely on the final documentation (including the most recent Key Investor Information Document, if applicable, which is available on [ db.com]) relating to the transaction and not the summary contained herein. These documents are available free of charge from Deutsche Bank, London Branch. DB is not acting as your financial adviser or in any other fiduciary capacity with respect to this proposed transaction. The transaction(s) or products(s) mentioned herein may not be appropriate for all investors and before entering into any transaction you should take steps to ensure that you fully understand the transaction and have made an independent assessment of the appropriateness of the transaction in the light of your own objectives and circumstances, including the possible risks and benefits of entering into such transaction. For general information regarding the nature and risks of the proposed transaction and types of financial instruments please go to riskdisclosures. You should also consider seeking advice from your own advisers in making this assessment. If you decide to enter into a transaction with DB, you do so in reliance on your own judgment. The information contained in this document is based on material we believe to be reliable; however, we do not represent that it is accurate, current, complete, or error free. Assumptions, estimates and opinions contained in this document constitute our judgment as of the date of the document and are subject to change without notice. Any projections are based on a number of assumptions as to market conditions and there can be no guarantee that any projected results will be achieved. Past performance is not a guarantee of future results. This material was prepared by a Sales or Trading function within DB, and was not produced, reviewed or edited by the Research Department. Any opinions expressed herein may differ from the opinions expressed by other DB departments including the Research Department. Sales and Trading functions are subject to additional potential conflicts of interest which the Research Department does not face. DB may engage in transactions in a manner inconsistent with the views discussed herein. DB trades or may trade as principal in the instruments (or related derivatives), and may have proprietary positions in the instruments (or related derivatives) discussed herein. DB may make a market in the instruments (or related derivatives) discussed herein. Sales and Trading personnel are compensated in part based on the volume of transactions effected by them. The distribution of this document and availability of these products and services in certain jurisdictions may be restricted by law. You may not distribute this document, in whole or in part, without our express written permission. DB SPECIFICALLY DISCLAIMS ALL LIABILITY FOR ANY DIRECT, INDIRECT, CONSEQUENTIAL OR OTHER LOSSES OR DAMAGES INCLUDING LOSS OF PROF- ITS INCURRED BY YOU OR ANY THIRD PARTY THAT MAY ARISE FROM ANY RELIANCE ON THIS DOCUMENT OR FOR THE RELIABILITY, ACCURACY, COM- PLETENESS OR TIMELINESS THEREOF. DB is authorised under German Banking Law (competent authority: BaFin - Federal Financial Supervising Authority) and regulated by the Financial Services Authority for the conduct of UK business. Passion to Perform is not a product performance guarantee. Deutsche Bank AG All rights reserved. Important Information 15

16 Further Product Information Further product information on the db X-trackers ETFs, including the Key Investor Information Document and full prospectus are available on the website: Alternatively you can contact us in writing, by telephone or by on the details provided below. Deutsche Bank AG db X-trackers Team Winchester House 1 Great Winchester Street 4th Floor WH/04/KD15 London EC2N 2DB Hotline: Phone calls will be recorded info.dbx-trackers@db.com Bloomberg: DBETF < GO > Reuters: DBETF Printed on environmentally friendly paper. August 2011 Deutsche Bank AG D Frankfurt am Main