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Exchange Traded Funds

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Exchange Traded Funds

  1. 1. Exchange-Traded Funds
  2. 2. What are Exchange-Traded Funds? <ul><li>© 2010 Morningstar. All Rights Reserved. 3/1/2010 </li></ul><ul><li>Index fund </li></ul><ul><li>Track one specific index </li></ul><ul><li>Buy/sell like stocks </li></ul><ul><li>Price set by underlying index </li></ul>
  3. 3. ETFs are a Fast-Growing Investment Vehicle Assets and number of funds 1995 – 2009 <ul><li>© 2010 Morningstar. All Rights Reserved. 3/1/2010 </li></ul>• Number of funds • Assets 0 100 200 300 400 500 600 800 Funds 700 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 0 100 200 300 400 500 600 $800 bil 700 2 19 19 29 30 80 102 113 119 152 204 359 728 629 797
  4. 4. What Kinds of ETFs are Available in the Market? <ul><li>© 2010 Morningstar. All Rights Reserved. 3/1/2010 </li></ul><ul><li>Track a variety of indexes </li></ul><ul><ul><li>Domestic and global </li></ul></ul><ul><ul><li>Sectors or industry groups </li></ul></ul><ul><ul><li>Style-specific such as growth and value </li></ul></ul><ul><ul><li>Equity and fixed income </li></ul></ul><ul><li>May focus on market capitalization (small-, mid- and large-cap) </li></ul><ul><li>May concentrate on characteristic-based diversification (dividend income) </li></ul>
  5. 5. Comparison of ETFs and Index Funds <ul><li>© 2010 Morningstar. All Rights Reserved. 3/1/2010 </li></ul>Purchased as blocks of shares Bought and sold throughout the day on an exchange Passive management Portfolio changes occur when underlying index changes Brokerage and trading costs ETFs Purchased directly from the fund Priced at market close each day Passive management Portfolio changes occur when underlying index changes Ongoing management fees Possible commissions Index funds Ownership Pricing Management style Costs
  6. 6. Assets of ETFs and Index Funds As of December 2009 <ul><li>© 2010 Morningstar. All Rights Reserved. 3/1/2010 </li></ul>$7.9 400 0 100 200 300 $500 bil Specialty Small-cap Mid-cap Large-cap Bonds Foreign equity • Index funds • Exchange-traded funds $453.0 $46.2 $145.3 $98.1 $32.4 $218.6 $94.5 $35.9 $100.5 $193.3 $36.4
  7. 7. Categories of ETFs <ul><li>© 2010 Morningstar. All Rights Reserved. 3/1/2010 </li></ul><ul><li>Traditional equity </li></ul><ul><li>Traditional fixed income </li></ul><ul><li>Commodity/currency </li></ul><ul><li>Fundamentally weighted </li></ul><ul><li>Quantitatively enhanced </li></ul><ul><li>Leveraged/short </li></ul>
  8. 8. ETF Market Coverage By assets as of December 2009 <ul><li>© 2010 Morningstar. All Rights Reserved. 3/1/2010 </li></ul>43% 14% 15% 28% • Domestic • International • Fixed income • Specialty
  9. 9. Expense Ratios of Large-Caps: ETFs, Index Funds, Active Funds As of December 2009 © 2010 Morningstar. All Rights Reserved. 3/1/2010 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4 1.5 1.5+ 0 0 0 Expense ratios of ETFs Expense ratios of index funds Expense ratios of active funds 20 Funds 10 20 1500 Funds 1000 500 40 Funds
  10. 10. Average Turnover Ratio Large-cap ETFs versus index and active funds as of December 2009 <ul><li>Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. © 2010 Morningstar. All Rights Reserved. 3/1/2010 </li></ul>50% 55% 0 20 40 60 100% Index funds Active funds 92% ETFs 80
  11. 11. Active Versus Passive Fund Strategies As of December 2009 <ul><li>Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2010 Morningstar. All Rights Reserved. 3/1/2010 </li></ul>% of active funds outperforming their respective Morningstar style index Index returns (%) 1-Year Value Core Growth Small Mid Large 91.36 11.38 69.97 21.52 16.83 44.37 25.83 36.05 29.63 38.94 41.43 42.05 17.89 40.28 24.39 39.86 48.46 32.98 Value Core Growth Small Mid Large 81.07 – 10.85 22.37 – 3.28 38.44 – 1.95 54.00 – 6.27 41.98 – 4.61 38.13 – 2.97 28.10 – 4.15 36.46 – 5.49 30.12 – 3.90 3-Year Value Core Growth Small Mid Large 57.02 – 0.94 19.95 1.65 75.75 0.60 28.00 1.76 25.66 1.85 25.19 3.09 17.12 2.13 22.52 1.69 33.07 0.65 5-Year
  12. 12. Risk Factors of ETFs <ul><li>© 2010 Morningstar. All Rights Reserved. 3/1/2010 </li></ul><ul><li>Market risk </li></ul><ul><ul><li>Stocks tracked by an ETF are subject to the same risks as traditional equities </li></ul></ul><ul><li>Interest rate risk </li></ul><ul><ul><li>Fixed income ETFs are subject to fluctuations in interest rate environment </li></ul></ul><ul><li>Currency risk </li></ul><ul><ul><li>International ETFs are subject to risk of capital loss due to currency fluctuations and a country’s economic factors </li></ul></ul><ul><li>Credit risk </li></ul><ul><ul><li>Value and ability of ETF fund is compromised if issuer is unable to make payments of principal and interest </li></ul></ul>
  13. 13. Pros and Cons of ETFs <ul><li>© 2010 Morningstar. All Rights Reserved. 3/1/2010 </li></ul><ul><li>Pros </li></ul><ul><li>Tool for implementing asset allocation strategies </li></ul><ul><li>Passive diversification </li></ul><ul><li>Transparency of price </li></ul><ul><li>Tax efficiency </li></ul><ul><li>Protection against cash drag </li></ul><ul><li>Cost advantages </li></ul><ul><li>Cons </li></ul><ul><li>Brokerage costs </li></ul><ul><li>Market pricing </li></ul><ul><li>Relatively new with limited track record </li></ul><ul><li>Limited selection in certain asset classes. For example: fixed-income ETFs </li></ul>

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