On Track. Focus on ETF Performance. For professional clients only

Transcription

1 On Track Focus on ETF Performance For professional clients only

2 Introduction ETFs have been designed to provide low-cost and transparent access to the world s markets, combining the simple tradability of a share with the diversified market access of a mutual fund. However, with so many ETFs on the market, it can be hard to know which is the right fund for an investment portfolio. This document aims to examine two measurements of ETF performance tracking difference and tracking error and the factors that can influence these measurements. We also examine the Total Cost of Ownership for ETFs and how both explicit and implicit costs can weigh on fund performance over the short and long term. The factors u 3 The effects u 5 Tracking at HSBC u 6 What to consider when investing in an ETF u 8 Important Information u 9 1 On Track: HSBC s Focus on ETF Performance

3 Introducing Tracking Difference and Tracking Error When considering the performance of an investment in ETFs, there are two common indicators that are widely used tracking difference and tracking error. Although these two terms sound similar, they are in fact quite different. So, it is perhaps useful to consider the difference between tracking difference and tracking error. Tracking difference measures the total return difference between the net asset value (NAV) of an ETF and its benchmark index over a given period of time. Tracking error is a measurement of risk that defines how consistent this return difference between the ETF and its benchmark index has been over time. Both measures are related, in the sense that a high tracking error would imply larger variations in returns and, therefore, greater volatility in the fund s tracking difference. Where they are different is that tracking difference reflects the amount of outperformance or underperformance against the benchmark index, while tracking error is an absolute figure of variation and does not show the direction of the tracking difference (i.e. whether positive or negative), only the extent of its volatility. Tracking difference tends to be the more commonly used measurement and is widely reported by ETF providers. However, HSBC believes that tracking difference and tracking error are both important measurements of ETF performance. For ETF investors with a short-term investment horizon, tracking error can be a more important measure as it allows them to gauge the level of possible net asset value (NAV) variation from the index on any given day of the investment. For example, if the tracking error of a given fund calculated using daily NAVs is 4 basis points (bps), this means that the maximum deviation of the NAV from the index on any given day would be 4bps either above the benchmark or below it. For ETF investors with a longer-term horizon, we believe tracking difference is the more important measure. It reflects the ultimate excess return that the investor would have achieved by investing in an ETF for a given time period (say 1, 2 or 3 years), be it outperformance or underperformance versus its benchmark. HSBC s investment approach across its range of equity ETFs is to keep both tracking error and tracking difference as low as possible. On Track: HSBC s Focus on ETF Performance 2

4 The factors The Total Cost of ETF Ownership The Total Cost of Ownership (TCO) in the case of an ETF is an all-inclusive figure covering both buying and holding a fund. Increasingly, the TCO is used by advisers for due diligence as it is relatively easy to calculate, and gives an effective way of measuring and comparing cost levels for different funds. As illustrated in the chart below, the TCO comprises not only all the fees and expenses making up the fund s tracking difference but also investors trading costs associated with buying and selling of ETF shares through a stockbroker. Total Cost of Ownership = Tracking Difference + Trading Costs Tracking Difference = Ongoing Charge Figure (OCF)* + Other Factors The top line of the chart shows the total costs that are incurred by someone who owns an ETF, which are made up of the fund s tracking difference and any trading/brokerage costs involved in the buying and selling of ETF shares. It is important to remember that, unlike an ETF, benchmark indices do not take into account any expenses associated with stock trading. This is why the investment managers running ETFs employ various techniques to minimise trading costs, ensuring that fund returns match closely the performance of the relevant index. The second line of the chart looks at the composition of tracking difference, which consists of the costs charged within the ETF. They are represented by the Ongoing Charge Figure (OCF) and other costs not covered by the OCF, such as the fund s brokerage fees and dealing costs, and interest on borrowing for example. The Ongoing Charge Figure (OCF) incorporates elements such as the management fee and a list of other costs carried by the asset manager, including administration, custody and audit fees, legal, regulatory and registration expenses. HSBC s ETFs are considered to be among the most competitively priced in Europe. *Ongoing Charge Figure (OCF): Charges taken from the fund over a year. This figure excludes transaction costs 3 On Track: HSBC s Focus on ETF Performance

5 Other factors that have an impact on fund costs, and subsequently the fund s tracking difference, can include, but are not limited to: Corporate actions Corporate actions (such as mergers, the issuance of new shares by a company or the receipt of interest and dividends) also need to be reflected by an ETF, which may then generate trading costs or other implicit costs to do with corporate activity in the underlying investment. When specifically considering dividends, there is the issue of dividend reinvestment, or cash drag. This is when fund performance can sometimes be affected by cash accumulation in the fund and a mismatch of payout schedules when compared to the underlying index. We believe that optimisation is still the best investment solution when it is not considered cost-effective to buy all of the securities in the index or for investors seeking exposure to harder-toaccess markets Index rebalancing When an index rebalances (adjusts its composition and constituents weights on a regular basis, usually every quarter), that is mirrored by ETFs tracking that particular index. In order to match the changes in their benchmark s composition, ETFs will buy and sell the stocks affected by the changes. This rebalancing activity on the part ETFs will incur trading costs, which will then have an impact on the funds tracking error and their performance relative to the index. Optimisation By definition, an optimised ETF (i.e. one that does not physically own 100% of the shares in the underlying index) will not fully replicate the constituents of the underlying index. This may lead to some variation in performance. However, we believe that optimisation is the best investment solution when buying all of the securities in the index is not considered cost effective (i.e. for very broad indices with large number of constituents, or indices with less liquid constituents), as well as in cases of harder-to-access markets. Taxation At the fund level, taxation can also add to the difference between the ETF s performance and that of its benchmark index. A common example of such a difference would be the withholding tax paid on dividends. An index might assume that the rate on a given dividend distribution is 30%, while the fund, as a result of a favourable tax treaty in the jurisdiction of that fund, might actually pay only 15%. The reverse is also possible and, in some instances, the fund might pay more than the index assumes in terms of withholding tax. On Track: HSBC s Focus on ETF Performance 4

6 The effects Why is a low tracking error important? A low tracking error means that the ETF is meeting its main investment objective, namely matching the returns of its benchmark index as closely as possible. Why would a high tracking error be a concern for an investment portfolio? If, over time, the tracking error of an ETF relative to its benchmark index becomes substantial, then the return objective of the overall investment portfolio may be compromised. Tracking error measures how much variability could exist between the NAV of the fund and its benchmark index on any given day. It is a statistical measure of the consistency of its returns compared to its benchmark index. A high tracking error will mean that the return of an ETF over a period of time consistently fails to match the performance of its benchmark index. While HSBC s approach is to minimise tracking error as much as possible, it is widely accepted that emerging markets funds would have slightly higher tracking error figures when compared to developed markets. This is to do with the complexities around accessing and trading emerging market equities. 5 On Track: HSBC s Focus on ETF Performance

7 Tracking at HSBC How does HSBC monitor index tracking day-to-day? HSBC s ETF investment management team is very experienced in managing index solutions and uses a variety of processes to ensure that an ETF tracks its benchmark index accurately, and that tracking difference is kept as low as possible. To start with, net asset value and performance attribution are calculated daily. The attribution calculation helps to identify the source of any potential deviation in fund performance and allows the team to monitor how closely the ETF is tracking its benchmark index. On an ongoing basis, HSBC monitors the impact of corporate actions, index rebalancing (and associated trading costs) and exchange rate fluctuations to ensure that tracking difference and tracking error are both minimised and that the ETF can track the benchmark as closely as possible. How well do HSBC physical ETFs track their indices? HSBC believes that the full replication physical approach to ETF investment (i.e. physically buying 100% of the stocks in the underlying index) is the best approach to take, as it allows us to construct ETFs with a high degree of transparency and simplicity, without compromising their ability to track an index closely (whether measured by tracking difference or tracking error). Our investment approach is primarily based on full replication (owning 100% of the shares in the underlying index) for 23 out of our 28 equity funds, with the remaining 5 funds using a technique known as optimisation (where we own a proportion of shares in the underlying index, as it is not cost-effective to buy all of the shares). Although some studies have shown that synthetic ETFs (which use swaps and other derivative products to obtain market access) can offer a lower tracking error over time than physical ETFs, we believe that the risks associated with such ETFs the most important of which is counterparty risk may make them a less attractive investment option. Moreover, it is not always the case that synthetic ETFs provide clear outperformance when compared to physical funds. HSBC has developed a range of physical ETFs (notably in Russia and Emerging Markets) that offer very competitive tracking performance compared to synthetic ETFs. This has been achieved by leveraging our local expertise in these markets, enabling us to carry out direct investment in local stocks wherever possible. This helps to reduce the tracking error of our funds. As an example, HSBC s MSCI Emerging Markets UCITS ETF has exposure of around 97.9% to local stocks, with the remaining 2.1% covered by investments in American Depositary Receipts (ADRs). This compares to the benchmark MSCI Emerging Markets Index split of 99.2% local exposure and 0.8% ADR exposure and makes it the ETF with the broadest coverage of local stock market exposure among its competitors 1.The HSBC MSCI Russia Capped UCITS ETF goes further, having exactly the same weighting (81%:19%) between local stocks and ADRs/ GDRs as the MSCI Russia Capped Index 2. This full replication element to our investment approach further reduces the potential for any significant divergence in tracking performance. HSBC is leading the market with its range of physical Russian and EM ETFs, giving clients access to markets that were previously primarily available via more risky synthetic ETFs. The HSBC MSCI Russia Capped UCITS ETF was the first Physical Russian ETF offered for sale in Europe. On developed markets as well, our range of equity ETFs (such as the HSBC MSCI Europe UCITS ETF and the HSBC S&P 500 UCITS ETF) aims to deliver minimal tracking difference and tracking error, while keeping costs (including Ongoing Charge Figure (OCF)*) as low as possible. *Ongoing Charge Figure (OCF): Charges taken from the fund over a year. This figure excludes transaction costs. 1 Source: HSBC Global Asset Management (UK) Ltd, as at 27 February Source: HSBC Global Asset Management as at 27 February 2015 On Track: HSBC s Focus on ETF Performance 6

8 Focus on Emerging markets More than half of HSBC s range of physical equity ETFs focus on Global Emerging Markets (18 out of 28 funds). Emerging markets are accounting for a rising share of international equity markets and consequently are increasingly playing a more important role in asset allocation within global investment portfolios. HSBC has a long track record in investing in emerging markets and we can subsequently offer direct market access through many local stock exchanges. We are therefore able to go further in offering physical ETFs based on this fast-growing market sector than other ETF providers. Moreover, the tracking error and tracking difference across our range of EM ETFs is very competitive, compared to both physical and synthetic Funds. Why choose HSBC? HSBC has a very strong record related to both tracking difference and tracking error across our range of equity ETFs when compared to our peers. This is the result of our robust approach towards portfolio management, trading and risk management. Indeed, based on this approach to efficient portfolio management, we have been able to demonstrate that physical ETFs can deliver better tracking difference than synthetic funds. Our ETFs are listed on the main European exchanges and registered for sale across many European markets, making it easier for clients to access them. For further information on our range of ETFs, please visit Moreover, our well-established footprint in global emerging markets means that we are well positioned to offer ETFs that invest in these fast-growing areas of the world. Lastly, HSBC s range of ETFs is managed by HSBC Global Asset Management, which has a strong track record of providing sound investment solutions to a wide range of clients around the world. Our range of ETFs covering both emerging and developed market equities dates back to In summary, HSBC aims to provide a range of equity ETFs that offer all of the advantages of physical replication, coupled with strong tracking performance and a competitive cost structure. 7 On Track: HSBC s Focus on ETF Performance

9 What to consider when investing in an ETF ETFs in a nutshell Exchange Traded Funds (ETFs) have a similar objective to traditional index tracker funds except they are listed on a stock exchange and are therefore tradable in real-time when the stock market is open, like shares. Most ETFs are index trackers, aiming to match the performance of a given index, such as the FTSE 100 or S&P 500. There are a variety of factors that make ETFs attractive to both individual and institutional investors: ` `Choice, with a huge range of ETFs in Europe providing access to a wide variety of markets, from mainstream developed markets to their emerging peers ``Relatively low cost ` `Simplicity of their investment objective in the case of index trackers and ``The ability to trade them like any listed stock About HSBC ETFs HSBC offers 26 ETFs in Europe with USD 3.2bn of assets under management 1. We have been managing ETFs since 2003, starting in Hong Kong through Hang Seng Bank. HSBC started offering ETFs in Europe in 2009 and now offers a wide range of ETFs that cover the main developed and emerging equity markets. All of our ETF range physically invest in index stocks in order to track index performance. The HSBC range of ETFs are all UCITS IV compliant, ISA and SIPP eligible and have UK Reporting Fund status. 1 Sources: HSBC Global Asset Management, end of September 2013 Simplicity and transparency Investors in ETFs have to choose between two fundamentally different fund investment methods, i.e. Physical or Synthetic (swap when the return of an asset is is exchanged against the return of another asset). For its entire ETF range, HSBC has decided to only use the physical investment method, whereby the fund holds all index constituents in the same proportion as they are included in the index. Synthetic ETFs use derivatives issued by a Counterparty (a third party involved in the transaction) to generate their performance without necessarily investing in any of the stocks in the index. Our commitment to investors is to keep HSBC ETFs as straightforward and simple as possible, with a tight control of risk. The physical investment method is therefore the default investment approach we will use for all our ETFs. Everyday, HSBC ETFs publish full lists of securities that they hold, in addition to fund factsheets on our website: This allows our current and potential investors to understand our funds investment objectives and the risks to which they are exposed. What are the risks? Market risk: The value of investments and any income from them can go down as well as up, and investors may not get back the amount originally invested. Currency risk: Where overseas investments are held, the rate of currency exchange may cause the value of such investments to go down as well as up. Emerging market risk: Investments in emerging markets are by their nature higher risk and potentially more volatile than those inherent in some established markets. Geographic risk: Some ETFs invest predominantly in one geographic area and, therefore, any decline in the economy of this area may affect the prices and value of the underlying assets. Property risk: The value of interests in real estate companies may be affected by changes in interest rates, tax laws and environmental laws and regulations. While the value of interests in REITs may be affected by the value of the property owned or the quality of the mortgages held by the trust. Russian risk: There are significant risks inherent in investing in Russia, which could affect the value of investment. These include a lack of clarity in laws and regulations in the following areas: investor protection, banks and other financial services, the Russian economic system, taxation, transaction settlement and fiduciary duty and responsibilities of company management. Investors and potential investors should read the relevant Key Investor Information Document (KIID) and full prospectus and supplement for full details of the risks involves prior to making a decision to invest. If you have any doubt about the suitability of an investment you should consult a financial adviser. On Track: HSBC s Focus on ETF Performance 8

10 Important Information This document is intended for professional clients only and should not be distributed to or relied upon by retail clients. The material contained herein is for information purposes only and does not constitute investment advice or a recommendation to any reader of this material to buy or sell investments. Care has been taken to ensure the accuracy of this document, but HSBC Global Asset Management (UK) Limited accepts no responsibility for any errors or omissions contained therein. Fund information HSBC ETFs are sub-funds of HSBC ETFs plc, an investment company with variable capital and segregated liability between sub-funds, incorporated in Ireland as a public limited company, and authorised by the Central Bank of Ireland. The company is constituted as an umbrella fund, with segregated liability between sub-funds. Shares purchased on the secondary market cannot usually be sold directly back to the Company. Investors must buy and sell shares on the secondary market with the assistance of an intermediary (e.g. a stockbroker) and may incur fees for doing so. In addition, investors may pay more than the current Net Asset Value per share when buying shares and may receive less than the current Net Asset Value per Share when selling them. For investors in the UK All applications are made on the basis of the current HSBC ETFs plc Prospectus, relevant Key Investor Information Document ( KIID ), Supplementary Information Document (SID) and Fund supplement, and most recent annual and semi-annual reports, which can be obtained upon request free of charge from HSBC Global Asset Management (UK) Limited, 8 Canada Square, Canary Wharf, London, E14 5HQ. UK, or from a stockbroker or financial adviser. Investors and potential investors should read and note the risk warnings in the prospectus, relevant KIID, SID and Fund supplement. UK-based investors in HSBC ETFs plc are advised that they may not be afforded some of the protections conveyed by the Financial Services and Markets Act (2000), ( the Act ). The company is recognised in the United Kingdom by the Financial Conduct Authority under section 264 of the Act. Restrictions The shares in HSBC ETFs plc have not been and will not be offered for sale or sold in the United States of America, its territories or possessions and all areas subject to its jurisdiction, or to United States persons. Affiliated companies of HSBC Global Asset Management (UK) Limited may make markets in HSBC ETFs plc. Index disclaimer The funds or securities referred to herein are not sponsored, endorsed, or promoted by MSCI, and MSCI bears no liability with respect to any such funds or securities or any index on which such funds or securities are based. The Supplement to the Prospectus contains a more detailed description of the limited relationship MSCI has with HSBC ETFs plc and any related funds. Standard & Poor s and S&P are registered trademarks of Standard & Poor s Financial Services LLC ( S&P ) and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC ( Dow Jones ) and have been licensed for use by S&P Dow Jones Indices LLC and sublicensed for certain purposes by HSBC Global Asset Management (UK) Limited. The S&P 500 and the S&P BRIC 40 are products of S&P Dow Jones Indices LLC, and have been licensed for use by HSBC Global Asset Management (UK) Limited. HSBC Global Asset Management (UK) Limited s HSBC S&P 500 ETF and HSBC S&P BRIC 40 ETF are not sponsored, endorsed, sold or promoted by S&P Dow Jones Indices LLC, Dow Jones, S&P, their respective affiliates, and neither S&P Dow Jones Indices LLC, Dow Jones, S&P, their respective affiliates make any representation regarding the advisability of investing in such product(s) To help improve our services and in the interests of security, we may record and/or monitor your communications with us. HSBC Global Asset Management (UK) Limited provides information to institutions, professional advisers and their clients on the investment products and services of the HSBC Group. This document is approved for issue in the UK by HSBC Global Asset Management (UK) Limited who are authorised and regulated by the Financial Conduct Authority. Copyright HSBC Global Asset Management (UK) Limited All rights reserved. 9 On Track: HSBC s Focus on ETF Performance

11 Notes On Track: HSBC s Focus on ETF Performance 10

12 Contact For more information, please contact us: Telephone: +44 (0) Website: This document is approved for issue in the UK by HSBC Global Asset Management (UK) Limited, who are authorised and regulated by the Financial Conduct Authority. Copyright HSBC Global Asset Management (UK) Limited All rights reserved /AS/0315/ FP until