Alliance Trust Savings - Exchange Traded Magazine


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This magazine focuses on an asset class that has recently established itself as a front-runner in many individuals’ portfolio choices.
We look at why <a> Exchange Traded Funds (ETFs) </a> have become increasingly popular, what intrinsically they are, and how you can find out more and invest in them.

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Alliance Trust Savings - Exchange Traded Magazine

  1. 1. December 2012An introductory guide toExchangeTraded Funds
  2. 2. WELCOMEW elcome to our special one-off magazine, income from them may go down as well as up and you Exchange Traded, which focuses on an asset may not get back the original amount you invested. If you class that has recently established itself as a are unsure whether an investment is right for you, youfront-runner in many individuals’ portfolio choices. should seek professional advice. Different ETFs may haveWe look at why Exchange Traded Funds (ETFs) have specific risks, so make sure that the investment that youbecome increasingly popular, what intrinsically they are, choose matches the level of risk you wish to take. Beforeand how you can find out more and invest in them. investing make sure that you understand the associated documentation such as key features, risk factors, importantETFs are index tracking funds that are traded on an information and product such as the London Stock Exchange. Theycombine the ready-made diversification of unit trusts with Our guest journalist, David Stevenson, explains how ETFsthe simplicity of shares. The majority of ETFs are eligible are structured, breaking them down into simple terms withfor ISAs and attract no stamp duty. ETFs have some of the his straightforward analysis, and later on examines the riselowest annual charges of all collective investment schemes. of ETFs and their background. Our round table discussionBut remember as with any investments the value and the reveals the various strategies surrounding investment, with 4 How ETFs are structured 14 Exchange Traded round table in this 4 How ETFs are structured – the world of synthetics – David Stevenson examines the risks underlying ETFs. issue: 9 The Exchange Traded Top 20s – Funds Alliance Trust Savings customers have been buying. 10 Growth prospects in emerging markets – HSBC’s view of which markets to focus on 12 How to buy an ETF or ETC with Alliance Trust Savings – Garry Mcluckie gives a step by step guide.
  3. 3. helpful insight direct from investment professionals.Guest experts provide their views in feature articles fromHSBC, Deutsche Bank and Invesco PowerShares, whilstour article gives you the practicalities of investing inETFs – a “how to” guide.I hope you enjoy this ETF special edition, and wouldlike to hear from you about any other products ordevelopments you would like further informationabout. Please send any feedback or suggestions McLuckieMarketing DirectorAlliance Trust Savings 20 Dynamic asset allocation 24 The ETF Boom 14 Exchange Traded round table – a discussion about ETFs with our panel of experts. 20 Dynamic asset allocation – Manooj Mistry Alliance Trust Savings Limited of Deutsche Bank talks about the choices PO Box 164, available with ETFs. 8 West Marketgait 22 The Power of Fundamentals – Ravinder Azad Dundee DD1 9YP of Invesco reviews the stock markets. Tel +44 (0)1382 573737 24 The ETF Boom – David Stevenson gives an Fax +44 (0)1382 321183 overview of the ETF market. Email Web
  4. 4. 4 EXCHANGE TRADED | How ETFs are Structured Over the past decade a quiet revolution has ripped through the normally fairly placid world of investment. How ETFs are structured I n the good old days, investors David Stevenson is a financial journalist and media entrepreneur. looking to buy exposure to a major He writes the Adventurous Investor market like the FTSE 100 or the column for the weekend Financial Times and the Contrarian column for American S&P 500 had two simple choices – industry newspaper Investment Week. buy an actively managed fund that invested He’s also a regular contributor to the in the companies in this index, or buy the Investors Chronicle and has written a number of books on investing for actual companies in the index as individual the FT and Prentice Hall including stocks. Plenty of investors have continued to the main reference book on ETFs. stick with this traditional style of investing David was also a senior producer but a much cheaper and hugely popular in television – working on a range of programmes at the BBC alternative (in the USA at least) has emerged including The Money Programme in recent years. This consists of investing in and Tomorrow’s World - before David Stevenson setting up the successful corporate a fund that ‘tracks’ a major index such as the Investment Columnist communications agency The Rocket FTSE 100 or S&P 500. The actual tracking – Financial Times Science Group. He’s now a partner in as we’ll discover - is very simple to the web TV platform Watering Hole and is involved with helping media understand and involves the ‘fund’ manager companies raise funding through the (for it is a fund) buying the long list of Coalition Partners investment group. In whatever spare time he has left, constituent stocks in the index. David is also a magistrate and he even finds time to edit his own investment The actual structure of the resulting fund will newsletter called PortfolioReview. vary enormously with the big choice being between an unlisted, traditional unit trust or a
  5. 5. How ETFs are Structured | EXCHANGE TRADED 5London stock market listed exchange tradedfund (also known as an ETF). Just to confuse an ETF is like anything else in the world of investment – there are some specific risks which “Whatever fundmatters there are other fund and product we’ll talk about later in this article but also some structure youstructures with even more exotic acronyms big positives, namely lower cost, and doing awaywhich we’ll examine in a later article but for with the risk of trusting a fund manager to make choose, as anour purposes they are all simply ‘index tracking’ lots of (hopefully profitable) trading decisions. investor you arefunds of one shape or another. More and more investors here in the UK are choosing to make use of ETFs and other index simply ‘buyingWhatever fund structure you choose, as aninvestor you are simply ‘buying the market’ tracking funds as part of their diversified portfolios. The key is to understand exactly the market’ viavia an index. When compared to a traditional‘active’ fund manager such as an investment what you are buying into. an index.”trust there are three big differences. Investing in the FTSE 100 IndexThe first and most important is that you’vedecided to dispense with the services of a fund Let’s imagine that you have decided to invest inmanager who will actively manage your the world’s leading blue chip equity index, whichinvestments based on their own views about is the American Standard and Poors 500 index.the relative risks and rewards of a company in For whatever strategic reason you’ve decidedan index such as the FTSE 100 or S&P 500. That that this benchmark index gives you the rightopens up the investor in an index tracking fund exposure to the world’s leading, profit makingto a very specific risk which is that the index companies. You’d thought about investing in the big stocks within the index – outfits likethey are tracking might be full of absolute junk Apple and Exxon – but you decided that youi.e. over-priced stocks that the market has wanted more diversification and didn’t want tochased up in value to ridiculous prices. take the risk of picking the wrong stocks.But in dispensing with the services of an active Which ETF to invest in? There are, as you canfund manager, our ETF investor has also avoided imagine, dozens of S&P 500 trackers, issued bya big risk, which is that the active fund manager a multitude of large banks and fundhas made wrong decisions about the companies management groups. You decide – for right orthey pick. Academics have endlessly studied fund wrong – to invest in the biggest of them all, inmanager returns over the last 50 years and fact probably the largest ETF on the planet.they’ve concluded that most fund managers don’toutperform the ‘benchmark index’ such as the This is an American listed ETF with theFTSE 100 and the S&P 500. With index tracking New York ticker SPY and it is managed byfunds you are simply buying whatever the wider a huge fund management company calledmarket is choosing to buy (as measured by an State Street.index) and doing away with the ‘idiosyncratic’risks of opting for an active fund manager. What’s inside the ETF?Last but by no means least by investing in a What does the fund actually invest in? As youfund that is passively managed (we use the term might expect, SPY invests in the constituents ofpassive because there is no active fund manager the S&P 500 benchmark US index. In the tablebut simply a plan to methodically buy whatever below State Street has listed the top tenis in an index) you are cutting your costs very holdings within the index tracking fund, withsubstantially. Many investment trusts still charge familiar names such as Apple, Exxon andmore than 1% per annum for their active Microsoft topping the list. Needless to say theremanagement, whilst more than a few unit trusts are another 490 stocks above and beyond thesecharge well over 1.5% per annum. ETFs and top ten holdings. You’ll also see that againstindex tracking unit trust funds rarely ever charge company is its weight within the index – in themore than 1% per annum, with most charging a SPY fund, shares in Apple comprises 4.8% ofgood deal less than 0.5%. That extra 1% of costs the total value of the fund. If we were to look atcharged by active managers can add up to a the composition of the index, there would behuge amount over 10 or 20 years. almost no difference whatsoever – the contentsWhat should become apparent is that the of the ETF would track (almost perfectly) thedecision to invest in an index tracking fund like composition of the index.
  6. 6. 6 EXCHANGE TRADED | How ETFs are Structured “...we might Top fund holdings in SPY index tracker* Physical tracking or replication is fine if one is tracking a very broad, very liquid, well known begin to start Name Weight (%) index such as the S&P 500 or the FTSE 100. Apple 4.80% These indices contain dozens of well knownworrying about Exxon Mobil 3.20% names traded in the world’s leading equity something Microsoft International Business Machines 1.80% 1.79% markets, where there are literally tens of thousands of professional institutions called the Chevron Group 1.73% operating on a real time basis. General Electric 1.73% tracking AT&T 1.68% But some indices aren’t quite as liquid, or ‘efficient’. These indices might track, for error...” Johnson & Johnson 1.46% instance, Indian equities or track a very Procter & Gamble 1.43% Wells Fargo & Co 1.43% specialised bit of the UK mainstream equity space such as small cap emerging market * As of 21/8/2012 stocks that pay a high yield. Within these specialised indices there may be all manner Understanding the tracking structure of complications – for whatever reason, physically tracking a specialist index might How do the ‘passive’ managers of this fund pull be a tad more complicated than tracking the off this tracking? The simple answer is that they FTSE 100. This needn’t prevent a fund use lots of computing power to make sure that provider from setting up a physical index they constantly track the index via their fund, tracking fund, but their management costs plus an active trading desk. If the price of a stock might be a little higher. Also we might declines by 10% in value on one day, bringing begin to start worrying about something its weighting within the index down from say called the tracking error. 4.85% to say 4.4%, the fund managers at an ETF sell their holdings of this stock to make up the This complex sounding term is actually difference – and vice versa. The key to this very simple to understand as it involves particular index is that the managers are measuring the returns from the underlying physically replicating the index i.e. if it says it’s index against the returns from the fund. In in the index, the fund managers make sure that some cases a big difference of as much as 1% a those actual physical shares are in the fund. That year might emerge. There are many reasons physical tracking is the norm in the US market why this tracking error might emerge, not least and is very common here in the UK. those bigger management fees, but the net effect can be drastic. Imagine if your ETF was tracking an index and was supposed to have The synthetic tracker alternative returned 5% last year but the fund actually But there is a newer alternative which involves only returned 3.5% – in this example our a novel twist, called the synthetic tracker. tracking error is 1.5%.
  7. 7. How ETFs are Structured | EXCHANGE TRADED 7How does a Synthetic Tracker work? Behind the scenes the value of the swap and the associated collateral backing up this return has “As an investorAll this talk of tracking error and less liquidindices has spawned a rival to the physical simply increased from a total of £100m you need to (probably comprising £90m in collateral and areplicating index tracking fund. This is called £10m swap contract) to £110m (£99m in balance thethe synthetic tracker fund and in essencethere is just one crucial change. collateral and £11m swap contract). The beauty potential of this synthetic tracking is that there need beA synthetic tracker fund following the FTSE no tracking error whatsoever and the issuer can reward of100, for instance, might do everything the also underwrite to pay out the total net return including dividends (once tax has been lower trackingsame as its peer which uses physical tracking(or replication) but with the synthetic fund, accounted for). Costs might also be substantially errors, accessits core holdings won’t be the stocks inside lower as a result and crucially, this syntheticthe actual index but what is essentially an swap is very efficient in dealing with less liquid to new marketsIOU. The issuer might be a large investment markets such as Indian equities. and lowerbank that already holds all those stocks withinthe S&P 500 as part of its normal trading The downside of a synthetic tracker should be immediately obvious. The investor is taking a expenses withportfolio. The bank’s trading desk simplyissues an IOU to the fund which says that risk with that IOU. It is in essence a gamble on the downside the credit worthiness of the bank issuer, whichthey’ll promise to pay out on the return from introduces the concept of ‘counterparty risk’. of counterpartyinvesting in the index. As collateral they’llissue what is called a swap (a kind of The bank will do its utmost to mitigate that risk risk.” for you, by offering up that collateral. Thecomplicated IOU) which is that promise regulators will also probably force the bank and(measured against the return from the index) the issuer to limit that exposure to the swapas well as collateral to back up the promise or contract to 10% at most of the value of the fund.‘contract’. That collateral can come in many But there is no getting away from the fact youdifferent shapes and sizes and could be are taking a risk. As an investor you need towhatever stock the bank holds within its balance the potential reward of lower trackingtrading portfolios at the time. errors, access to new markets and lower expensesHow does this IOU work? For argument’s sake with the downside of counterparty risk. Thelet’s imagine that our synthetic tracker is debate between physical and synthetic trackingfollowing the FTSE 100 over the next year. The has become very heated in recent years andfund starts with a market cap of £100m when many investors have what can seem like anthe FTSE 100 index is at 5,000. One year later irrational distrust of synthetic ETFs. There arethe index has gone up by 10% and the index pluses and minuses for both forms of tracking –level is now 5,500. Our fund should now be investors simply need to understand the risksvalued at £110m. and make a considered judgement.
  8. 8. 8 EXCHANGE TRADED | How ETFs are Structured Your checklist for using ETFs “It’s important to note Is it an exchange traded fund or a that this stock lending is unit trust? carefully managed and This is perhaps the most basic issue for many private investors. Most of the index tracking monitored – you need to funds on offer are shares based funds that are make your own decision ‘listed’ on an exchange, and thus the acronym used to describe them starts with an E, as in if you are happy with exchange. That means you’ve got to buy and sell through a stockbroker, who can deal in the procedures and the real time – although there will also be a bid collateral on offer.” offer spread between the asking and selling price. Many investors don’t have accounts with stockbrokers but use an adviser who actually own. The borrower of stocks and might not even have access to a dealing bonds in an iShares ETF portfolio will platform. If this is the case they’ll probably obviously have to pay a fee for the duration of use an index tracking unit trust fund or OEIC the loan. They’ll also lodge ‘collateral’ in where the fund is structured in almost exactly return which can amount to as much as 145% the same way as an exchange traded fund but of the value of the loan in some isolated cases with dealing on a daily basis. and more than 100% of the value of the loan in nearly all other cases. Counterparty risk – how big a problem is it? Stock lending is a perfectly acceptable practice Exchange traded notes and certificates have – many actively managed funds also engage in an obvious risk – they are in effect an IOU securities lending – nevertheless there is still by a large financial institution, a form of potential for concern with this stock lending. securitised derivative. But that risk can also What happens if the borrower of shares in the be overstated and can blind investors to the fund goes bust? How easy will it be to grab advantages of using synthetic replication. back and sell any collateral offered up by that Investors also need to remember that all borrower? Yet it’s also important to note that listed products – funds, notes and certificates this stock lending is carefully managed and – are not covered by the Financial Services monitored – you need to make your own Compensation Scheme (FSCS). Invest in decision if you are happy with the procedures any exchange traded fund at your own risk – and the collateral on offer. the government will not bail you out. How liquid is the ETF? Stock Lending activity – how much goes ETFs have become very popular in on and who benefits? Europe, with trading volumes exploding in If you do invest in a physical tracker you’ll recent years. But that liquidity can also be a probably be confident that your counterparty curse as markets stress or liquidity seizes up. risk is very low, as your fund manager owns Markets-makers may choose to expand the bid that big basket of shares you are tracking. But offer spread on lightly traded ETFs to there is another risk that you need to be aware unacceptable levels – these spikes in bid offer of based around something called stock spreads can also move around on an intra day lending. Those physical baskets of liquid trading basis. These excessive bid offer spreads assets represent a real opportunity for a also point to a bigger challenge – exchange sophisticated organization like iShares and traded products of all shapes and sizes may be its parent Blackrock – why not lend out the the big new thing in Europe but that listing share and bond certificates within its portfolio activity hasn’t always translated through into for limited periods of time to external actual ‘action‘ on exchange – many European organizations who might to borrow them? ETFs, for instance, boast low Average Daily Volume (ADV) numbers. The ‘borrowers’ are likely to be hedge funds or bank trading desks who might have a particular view on a company (bearish or Opinions expressed are those of David Stevenson, not bullish) and want to make a quick profit by Alliance Trust Savings Limited. Please read the speculating on stocks and bonds they don’t important information at the end of this publication.
  9. 9. Top 20s | EXCHANGE TRADED 9EXCHANGE Traded Funds Top 20s T ake a look at which Exchange Traded Funds Alliance Trust Savings customers bought between 1 January 2012 and 31 October 2012. Rank Asset 1. iShares FTSE 100 2. ETFS Physical Gold 3. iShares S&P 500 4. ETFS FTSE 100 Super Short Strategy 5. iShares Markit iBoxx Corporate Bond Ex Financials 6. iShares Index Linked Gilts 7. iShares Markit iBoxx Euro Corporate Bond 8. iShares Markit iBoxx £ Corporate Bond 9. iShares Physical Gold 10. iShares treasury Bond 1-3 11. db X-trackers FTSE 100 Short Daily 12. iShares Dow Jones Emerging Markets Select Dividend 13. iShares $ Emerging Markets Bond 14. ETFS Physical Silver 15. iShares FTSE UK All Stocks Gilt 16. iShares FTSE 250 17. iShares FTSE UK Dividend Plus 18. db X-trackers MSCI AC Asia ex-Japan 19. SPDR Euro S&P $ Dividend Aristocrats 20. SPDR Euro S&P £ Dividend Aristocrats The table confirms the purchases of investors at that time; no reliance should be placed on the position of any company in making any investment decisions. The rankings are based on the value of all purchases made by Alliance Trust Savings customers in the Select SIPP, ISA and Investment Dealing Account. Alliance Trust Savings does not provide advice. If there are any terms you are unfamiliar with or you are unsure of, you may wish to seek financial advice.
  10. 10. 10 EXCHANGE TRADED | HSBC Global Asset Management Growth prospects in markets are still stro which markets to At a time when developed A t a broader level, emerging nations have undoubtedly risen like a phoenix from the ashes of their own disasters, market countries seem to such as the Russian financial crisis of 1998. Today, be forever embroiled in emerging markets are the engine of global growth; while Western economies stagnate, countries such as Brazil, Russia, India and debt crises, hindered by China (termed BRICs) continue to grow. At HSBC, we believe that lacklustre economic data these economies are likely to be the driving force of the new global and beset by volatile equity economy. In our opinion, they offer attractive investment opportunities, for the following reasons. markets, the emerging First of all, the BRIC economies have, to varying degrees, shown market bloc continues rapid economic growth, increasing market size across all sectors. to show remarkable They also have a burgeoning middle class, providing a rich source of potential consumption. Each of the BRIC countries also has resilience. In truth, a new multiple and different attributes and, thus, each is distinct. world order seems now Brazil, the fifth-largest country by area and population in the to be forming, with the US, world, has a wealth of mineral reserves and a focus on energy once the undisputed king resources, commodities and agriculture. of the global economy, Russia is the world’s largest country in terms of territory, with a consumer market of over 140 million people, vast natural seeing its crown being resources, a highly educated workforce, and technologically slowly usurped by China. advanced research and production capabilities.
  11. 11. HSBC Global Asset Management | EXCHANGE TRADED 11 India has the second-largest population in the world with The four countries also complement each a young and vibrant workforce. The Indian economy benefits other. China, as one of the leading from specialisation in services, outsourcing, technology and manufacturing countries in the world, depends pharmaceuticals. on the importation of commodities and energy from Brazil and Russia. Meanwhile, India China, with 20% of the world’s population, is the most provides the IT services that make it possible to populous in the world and has raced up the GDP ladder in optimise the use of new technology. The the last decade. Indeed, China is one of the fastest-growing continued requirement of commodities from economies in the world with an annual growth rate in excess Brazil and Russia will help boost the economies of 10% over the last 30 years. In early 2011, it surpassed Japan of both countries. Meanwhile, India and China as the second largest economy and seems set to replace the USA by as early as 2020. It is already the world’s largest exporter of have benefited from the recent global economic goods and is a leading global manufacturer across a wide range crisis, as they are net importers. Overall, these of industries, facilitated by its abundant labour resources. factors make the BRIC bloc compelling from an investment standpoint.n emerging At HSBC, we have a number of products that aim to take advantage of these opportunities. We have recently launched a renminbi fixed income fund, which aims to allow investors to gain exposure to the renminbi, China’song – currency, and to benefit from its potential appreciation via investment in the offshore bond market. We also believe that Russia is of particular interest and, in July 2011, launched the firstto focus on physically replicated Russian ETF in Europe. ETFs are attractive as investments not only because of their low costs, tax efficiency and stock-like features – but also because they provide investors with a way of tapping into less Furthermore, BRIC countries have compelling long-term accessible markets. HSBC’s physically replicated growth potential. The sustained growth of BRIC economies Russian ETF tracks the MSCI Russia Capped has been based on a combination of demographic factors, Index, which represents the top 85% by market increased industrialisation and a wealth of natural resources. capitalisation of listed companies in the Russian The pace of growth has seen their international significance investable equity universe. The tracking of this increase rapidly, challenging the traditional economic index ensures the ETF is highly correlated with dominance of developed markets. Recent growth has been the Russian market. Furthermore, the fund has driven by domestic rather than export demand, reducing so far has delivered better tracking-error BRIC reliance on their developed markets trading partners. difference than most swap-based ETFs since its The outlook for BRIC nations is also promising. Growth rates launch date. By harnessing all of HSBC’s in the BRIC countries are widely expected to exceed those of capabilities, we have been able to manage both western markets, especially China and India. Their stronger Russian equity and broader emerging market outlook has been a key reason for the large investment ETFs on a physical and competitive basis that inflows seen in recent years. are of high quality and good value. This article has been issued and approved by HSBC Global Asset Management. 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. Investments in emerging markets are by their nature higher risk and potentially more volatile than those inherent in some established markets. Stock market investments should be viewed as a medium to long term investment and should be held for at least five years. The article is for information only and does not constitute investment advice or a recommendation to any reader to buy or sell investments. The views expressed were held at the time of preparation and are subject to change without notice.
  12. 12. 12 EXCHANGE TRADED | Alliance Trust Savings How to buy an ETF or ETC with ALLIANCE TRUST SAVINGS You may be considering what the next steps are before deciding whether or not to become an ETF/ETC investor. T he process really is the same as prior to By clicking on the ETF tab (see table 1), you are taken to purchasing any investment and the key is always the main Morningstar page which contains a snapshot do your research. Why? As well as being aware of information. This page is your ‘hub’ to access more of the potential benefits of any investment you have to be detailed information on the ETF/ETC of your choice. fully aware of the risks and how much risk you wish to The snapshot page is a good way of finding your feet take. Only by conducting thorough research can you and allows you to search by category if you’re interested make an informed decision, fully aware of the risks and in a particular sector. understand how much risk you are willing to take of both By using the drop down menus you can look at specific the risks and benefits of the underlying investment. ETF companies and their sectors such as Emerging At Alliance Trust Savings we understand the value Markets or Commodities. Once you have selected a of research in the investment decision process. We offer company you can view a particular investment by all our customers free access to research services from simply clicking on the investment name, which will Morningstar, a recognised player in investment research then provide access to more detailed information on expertise and facilitation. You can access information your chosen investment. You can also use the search from Morningstar on our website by clicking on the box and input the ETF name or Investment Symbol to Investment Selector tab at the top of our home page and find a specific investment. Once you have selected your then follow the instruction on that page which will take chosen investment you can view information via the you to the tool itself, or alternatively it is available when navigation on the left hand side (see table 2). you login securely to your account. In the next section of this article we will look at how In terms of ETFs and ETCs Morningstar holds a wealth you can purchase an ETF online with Alliance Trust of information for you to consider. Savings. If you decide to purchase an ETF or ETC with Side bar menu from table 2 (opposite) 1. Overview – Provides high level information 5. Portfolio – Includes information on market cap, including Morningstar category, performance history, prospective earnings, dividend yield factor, historical key stats, ISA eligibility and Inception Date. earnings growth and asset allocation. ETFs/ETCs 2. Chart – Growth of £1,000 across different invest in specific sectors and therefore asset allocation time frames will typically be 100% equities for example within a specific region or 100% in a specific region. 3. Performance – Performance history tracked against an index. Also gives annual, trailing and 6. Management – Contact information of the ETF/ quarterly returns ETC provider. Domicile, Legal structure, and whether or not the investment is a UCITs is also covered in 4. Risk and ratings – Morningstar risk rating this section. measured against category and return/risk analysis 7. Fees – Includes any fees and expenses that you will incur when buying into an ETF.
  13. 13. Alliance Trust Savings | EXCHANGE TRADED 13 Alliance Trust Savings you will be asked to logging in click on the Trading Centre tab confirm that you have read the relevant Key and then click trade now. It is important to Investor Information Document (KIID) before note that you cannot purchase an ETF/ETC completing the purchase. The KIID is really within the fund supermarket. If you have useful and provides important information. The ever purchased an equity with Alliance Trust good news is that you can access KIIDs again Savings online the process is exactly the through the Documents tab of Morningstar. same for ETFs/ETCs. The information contained within the KIID is To help you we have produced a list of all required by law to help you understand the the ETFs/ETCs available on the Alliance nature and the risks of investing in the ETF/ ETC. A KIID will only be provided where the Trust Savings platform and importantly the investment is classified as a UCITs. Investment Symbol that applies as you will need this for any purchases or sells. This There is much more information available and full list is available within the ‘forms and too much to cover here – Why not log into documents’ section of our website under your account today and find out more? Formal Documents. This list will also help you with your Morningstar Research as How to purchase an ETF/ETC with some investments displayed on Morningstar Alliance trust Savings are not available on our platform. Once you have completed your investment We hope you have found this short guide to Garry Mcluckie research and decided on which ETF/ETC to ETF/ETC research helpful. Our website has a Marketing Director purchase the easiest way to complete your range of ‘how to videos’ one of which is about Alliance Trust Savings purchase is online using our secure trading purchasing an ETF or ETC online – why not platform. To purchase an ETF or ETC after check it out? Happy investing. Garry joined Alliance Trust Savings in October 2010. His role is to manage the1 Investment Information Alliance Trust Savings product News/Commentary Funds UK Equities Int. Equities Investment Trusts ETF Search Enter name, ISIN or ticker and marketing strategy. ETF Quickrank Morningstar Tools Invesco Powershares Capital Mgmt LLC All Morningstar® Categories Contact: Enter name, ISIN or ticker Search Snapshot Short Term Performance Portfolio Fees & Details Documents Name Morningstar® Morningstar YTD Total Last For more information, please Category RatingTM Return Expense Close % Ratio% visit our website PowerShares FTSE RAFI All-World 3000 Fd GBP Global Flex-Cap Equity Not Rated 6.01 0.50 846.75 GBX PowerShares Dynamic US Market Fund US Large-Cap Blend Eq... 10.93 0.75 568.13 GBX PowerSharesEQQQ Fund GBP US Large-Cap Growth E... 11.28 0.30 4,036.00 GBX PowerShares FTSE RAFI AsiaPac x-Jpn Fund G... Asia-Pacific ex-Japan E... Not Rated 12.92 0.80 468.15 GBX PowerShares FTSE RAFI Dev 1000 Fund GBP Global Large-Cap Value... 5.00 0.50 743.13 GBX PowerShares FTSE RAFI Dev Eur Mid-Sm GBP Europe Mid-Cap Equity 10.79 0.50 715.00 GBX PowerShares FTSE RAFI EmergingMrkts Fund... Global Emerging Market... Not Rated 3.34 0.65 552.50 GBX PowerShares FTSE RAFI Europe Fund GBP Europe Large-Cap Valu... 7.83 0.50 564.63 GBX PowerShares FTSE RAFI Hong Kong China Fd... Hong Kong Equity Not Rated 18.92 0.55 1,282.00 GBX PowerShares FTSE RAFI UK 100 Fund UK Large-Cap Value Eq... 10.24 0.50 908.88 GBX PowerShares FTSE RAFI US 1000 Fund GBP US Large-Cap Value Eq... 7.03 0.39 631.88 GBX PowerShares Global Agriculture Fund GBP Sector Equity Agriculture 6.44 0.75 747.75 GBX2 Investment Information Morningstar® Fund ReportTM Morningstar Tools Overview db Physical Gold ETC XGLD The value of investments Chart Performance History 31/10/2012 Key Stats and the income from them Performance Growth of 1,000 (GBP) Morningstar® Category Morningstar RatingTM Risk and Rating 1,406 Commodities – Precious Metals Not Rated may go down as well as 1,332 Portfolio 1,258 1,184 IMA Sector - ISIN GB00B5840F36 up and you may not get Management NAV 30/10/2012 Day Change Fees 1,110 1,036 USD 169.81 0.64% back the original amount 962 Total Net Assets (mil) Total Expense Ration Print Glossary ? 2008 2009 2010 2011 2012 - Annual Management - Inception Date you invested. Fund - - - - - 12.1 5.8 Fee 15/06/2010 +/- Cat - - - - - 15.0 3.6 0.29% +/- Cat - - - - - - - ISA No Exchange Name LONDON STOCK If you are unsure whether an EXCHANGE, THE Category: Commodities – Precious Metals Index: – Benchmark investment is right for you, Trailing Returns 31/10/2012 Fund Benchmark or you are unfamiliar with Fund +/-Idx London Fix Gold PM PR USD YTD 5.84 - Morningstar® Benchmark the terminology, you should 3 Years Annualized - - - 5 Years Annualized 10 Years Annualized - - - - seek professional advice. 12 Month Yield 0.00 Tax Year Return 15.78% Past performance is not a guide to future performance. Screens for illustration purposes only. Source: Morningstar
  14. 14. 14 EXCHANGE TRADED | Round Table ROUND TABLE David Stevenson chairs a David: Why would ordinary investors invest in index-tracking discussion about Exchange funds? Why would they not go off and invest in investment trusts or a Traded Funds with a panel of standard unit trust? experts: Nick Blake, Jose Garcia- Jose: I think one of the key things about the Zarate and Manooj Mistry. philosophy behind passive investment, is acknowledging the inability of active managers to comply with their objectives. There are a lot This round table event was filmed at the Tate Modern, of studies that show over the long term, that London on 5 September 2012. To view the full discussion active managers are unlikely to fulfil their visit investment objectives.
  15. 15. Round Table | EXCHANGE TRADED 15 Nick Blake Head of Retail, Vanguard Nick Blake is Head of Retail. He is responsible for overseeing development of Vanguards fund range for the UK and European businesses and the distribution to our key retail audiences of Financial Planners, Wealth Managers and Asset Management Companies. Nick joined Vanguard in 2009 after a long career with a leading UK Life Office where he held senior positions in distribution, and more latterly as a key member of the team delivering a successful Wrap platform. Jose Garcia-Zarate Senior ETF Analyst, Morningstar Jose Garcia-Zarate is a senior ETF analyst for Morningstar, covering European ETFs. Before joining Morningstar in 2010, Jose spent seven years as a senior European sovereign bond market strategist for 4cast, a London-based consulting firm. Prior to 4cast, he was a macroeconomic analyst and Eurozone sovereign bond markets analyst for S&P MMS. Jose began his career as an analyst intern for Spain’s Economic Ministry, working in the external trade department in the ministry’s USA office. Manooj Mistry UK Head of db X-trackers, Deutsche Bank Manooj Mistry is UK head of db X-trackers, Deutsche Bank’s exchange traded funds (ETF) platform. Manooj joined Deutsche Bank in 2006 having previously worked at Merrill Lynch International, where he was responsible for the development of LDRS ETFs, the first ETFs to be launched in Europe. Manooj graduated in economics and business finance from Brunel University.This is not a question of actually saying that theactive managers are not good at what they do, or If you look at it from a regulatory perspective an ETF is the most highly regulated product, “The challengethat the rationale behind picking a certain stock an ETC is basically issued by a special purpose for investorsor a certain bond is not correct at the time, it’s vehicle and it trades like a security on thebasically measuring the performance over a long exchange and an Exchange Traded Note is is knowingterm period which is what investors should be typically a debt security issued by a bank.interested in. who will beat David: One of the most shocking the index.”David: What should investors really things is that the average fee charged Nick Blakefocus on? by average fund in Britain is actually going up not down over the last fewManooj: When you look at an ETF it is years and that’s across the entireessentially the index-tracking fund listed on an universe of funds, but how do ETFs orexchange and it trades like any other listed unit trusts compare in terms of cost?security so in the same way as with aninvestment trust you buy it on the exchange Nick: That’s the challenge for investors, it’sthrough your broker you can do the same with knowing in advance who will beat the indexan exchange traded fund. From a regulatory and that’s the real challenge. Now, as to theperspective ETFs are regulated as any other different types, certainly in our view anOEIC or unit trust, they conform to what’s Exchange Traded Fund, an index exchange-called the UCITS Regulations a pan-European traded fund and a mutual fund is actually theset of regulations that govern funds across same vehicle, it’s just a different way to buyEurope and you’ve also got the other ETPs the same exposure in that way, typicallyExchange Traded Products categories out there investors would find that an index fund or anso you’ve got Exchange Traded Commodities ETF would typically be much lower cost thanwhich are known as ETCs and typically these an active fund and that’s because active fundswill give you exposure to single commodities or put a lot of effort into research trying toa basket of gold or oil for example and then you outthink the market, trying to do the deepalso have other products called Exchange research to understand how they mightTraded Notes and these tend to be linked, once out-perform the market, an index fund isn’tagain could be linked to commodities but could trying to beat the market, it just buys foralso be linked to strategies such as volatility. example everything in the FTSE 100.
  16. 16. 16 EXCHANGE TRADED | Round Table David: How much would Gold is purely a safe haven strategy borne an average index-tracking out of the uncertainty in the global one charge? economic picture and people are looking to protect capital. It’s not so much that Nick: The usual sort of apples and apples they’re seeking to have positive returns comparison trouble here is that some of but at least preserve the capital and on the active funds include commissions the fixed income space you see a lot of and fees in them whereas many index interest in corporate bonds funds don’t pay commission and fees Manooj: The reason why you can offer a but on a like for like basis an index fund single commodity exposure to something would typically be half a percent to like gold is that the vehicles that the three quarters of a percent cheaper than products are issued by are vehicles that an active fund in general and as you say aren’t as regulated as funds, they are the compound effect of those charges regulated as special purpose vehicles could be quite significant. which have the opportunity to issue debt Jose: We ran a study at Morningstar or securities linked to one asset so they’re about the implications of high not subject to the same diversification management fees and it is astonishing rules you have in funds. how much of your long term returns can be eaten away by paying David: So they’re a little bit management fees. At 1% or 2% this riskier in their structure. doesn’t sound like a lot, but this is compounding year after year. Manooj: Yes but a lot of these products for example the gold products are called a Manooj: It’s very much like what we see whole physical – gold, tobacco products. is that ETFs give retail investors the same tools as institution investors have, institution investors have been using David: It might be safer in passive products for many years. some respects. Manooj: What you typically see with an exchange traded commodity is that gold David: Because a lot of people is held in a vault somewhere backing that have pension funds, would investment so these products are backed pension funds make use of by the actual gold bars sitting somewhere index tracking? so these products are what I would call Jose: They do because this is one of the collateralised or asset backed they’re key industries where you really need to physically backed by assets. make sure that the stream of revenue is David: And that’s a crucial thing more or less secure and it is one of the because when we talk about key reasons why I think the ETF market commodities in fact you sort of have to is actually kicking off with some go down that route don’t you because important growth rates in places like quite often they’re either physical the UK where you have a very holdings or they’re futures or they’re important pension fund industry. done on options exchanges so they can’t be held in the traditional way that an David: What are the kinds of equity fund would hold, you just can’t things that people are buying do it that way can you so that’s the out there at the moment? reason they’ve done it that way. Jose: Well lately it’s been about a search for yields and trying to find the safest David: What’s the big difference investments. So, you have the fixed in this physical versus synthetic income space gathering a lot of debate, what’s going on there? investors’ interest, and you have a It does sound very confusing commodity space of the ETFs. for many of us.
  17. 17. Round Table | EXCHANGE TRADED 17Jose: I think the first thing is to define is ‘what isa physical and what is a synthetic fund’. Physical Regulations I mentioned earlier so as a minimum a fund must at least have 90% assets. “ isis pretty easy to understand. The fund is either In many cases in the ETF industry many astonishinggoing to hold all the components of the index ora subset of the components of the index. providers are actually doing what is called over collateralisation so they’re actually assets greater how muchSynthetic providers or synthetic ETFs deliver thereturn of the indices via small contracts. than the value of the fund so these are basically an element of a cushion of security there. of your longThe key difference obviously in the structure is term returnsthat a synthetic ETF will always have a counterparty risk, that’s the nature of the structure David: To the outside observer who is used to traditional fund can be eatenbecause a counterparty, typically that is when an structuring, what are the away by highinvestment bank will have to provide the return advantages of doing it this way?of the index and there is always the risk even Manooj: The advantages of synthetic managementthough theoretical that the bank will not beable, for whatever reason, to provide that return. replication or swap based replication is that you fees year after can deliver the index performance without any tracking error / difference. This means that you year...”David: Manooj you do synthetic can guarantee that your returns will be the FTSE Jose Garcia-Zarateso just talk us through how you 100 index minus the management fees.structure a synthetic fund.Manooj: Jose has explained the first part in terms David: And to understand theof how the fund works, the fund is entering into a tracking error, it’s very simply an ideacontract with a bank to deliver the underlying which is that you say you’re going toindex performance then as part of that contract track the FTSE 100 and it turns inthe fund also needs to receive some physical assets 10% one year and you only turn inso this physical collateral is there to basically offset 9%, your tracking error will be 1%.the counter party exposure. The amount of assets Manooj: 1% yes and some of that 1% willthat need to be delivered or posted with the fund obviously be the management fee but there couldis determined by the regulations, by the UCITS be additional tracking error on top of that.
  18. 18. 18 EXCHANGE TRADED | Round Table David: So Nick you do a physical slight tracking error and a good adviser and approach and that sort of does what good investors really look for weighing off it says on the biscuit tin really you those trades around counter party risk versus buy the FTSE 100, you buy the perfect tracking. bunch of stocks in the FTSE 100, Manooj: You can get counter party risk with what are the advantages of that the physical replication to a certain extent approach do you think? Nick: Both methodologies (Synthetic and David: How does that work? I’ve Physical) achieve the same outcome for heard things like stock lending, what’s investors and both are covered by the European going on there? What’s that all about? UCITS Rules. Our preferred approach is physical, we like to own the securities and Jose: There could be counterparty risk in deposits that are there backing up the return for physical funds. investors. One of the challenges with physical is, as the funds get broader, so let’s say you’re David: How does that work, surely trying to track a more global index. if Nick has his 100 stocks, his FTSE 100 he’s got them in his safe and David: You hear things like the he has the certificates, what’s MSCI World. wrong with that then, what could go wrong there? Nick: Correct, and that might require you to own thousands of stock. Jose: The thing that could go wrong is that if he decides to actually lend those 100 securities And there could be a point of inefficiency to other parties then obviously you create an where trying to own a very small amount of a element of counterparty risk in the sense that very obscure opportunity means it’s those other parties might not return the inefficient for the fund manager to own that securities to the fund. Not all physical funds so whilst most physical managers will get as engage in securities lendings but a lot do. close as they can to the index and a really good one will do very well there you could start to see small amounts of tracking error David: What’s an interesting area out there that investors should just occur so really the trade-off for investors here keep an eye on, where there’s a lot is with synthetic you get a certainty of return of activity going on? because you have the promised return but have counter party risk versus no counter Manooj: I think what we’re seeing is that with party risk with physical but potentially a ETFs retail investors have the same tools as
  19. 19. Round Table | EXCHANGE TRADED 19institutional investors have and what we’vealready seen is a number of institutional broader access to these vehicles, better disclosure, more transparency just so that “...investorsportfolio managers using products like ETFs and investors have a far more informed way of have got farindex funds in their portfolios and they’re looking at their portfolios.using these products to do asset allocation so Jose: Perhaps it is the pending revolution for more choicerather than choosing individual stocks orbonds, they’re actually deciding OK I want the ETF market, the accessibility and the and, also in extensive use of Exchange Traded Products byexposure to a particular market or asset class. the retail community. I think that socially the how theyNick: The thing I’m most pleased with actually conditions are right for an increasedis not so much in the strategies themselves but participation of the retail community because index...”more in the access that investors have to these people have to save money for things such as Nick Blakestrategies so there was a time when low cost pensions and university costs.products wouldn’t be carried by many of theplatforms out there because quite frankly theydidn’t pay a commission being very low cost soinvestors really only had the choice of somerelatively expensive funds and things likeinvestment trusts or ETFs or no load mutualfunds typically wouldn’t be carried but one ofthe developments I’m delighted to see more This article is for information only. The views stated in the discussion are those offorward thinking platforms like Alliance Trust the panel members at the time, and not Alliance Trust Savings Limited. Please readare making the access to these vehicles far the important information at the end of this publication.wider now than has ever been before so Investments can down as well as up and capital is at risk so that investors mayinvestors have got far more choice and they’ve get back less than they originally invested.also got choice in how they index so in manyways an ETF is just another way to index like a Investments in emerging markets may involve a higher element of risk due to lessmutual fund but how they index can also have well-regulated markets and political and economic stability. Exchange rate changesan impact on cost as well, accessing these may cause the value of underlying overseas investments to go down as well as up.through a stock broking platform might be a Whilst care has been taken in compiling the transcript of the discussion, nocheaper way to go than accessing them representation or warranty, express or implied, is made by Alliance Trust Savingsthrough a traditional funds platform and Limited as to its accuracy or completeness.investors should think about not just the costof the fund itself but also the cost of ownership Nothing contained in this transcript of the discussion should be construed asof the fund just as much because both of those being an invitation or inducement to engage in investment activity. No advice iscosts will erode their returns over time so one given by Alliance Trust Savings Limited. For advice on investing, please consult anof the things I’m delighted to see is just the independent financial adviser.
  20. 20. 20 EXCHANGE TRADED | Deutsche Bank db X-trackers Dynamic asset allocation using ETFs Investors can use ETFs to build actively managed portfolios, or invest in a single ETF where an independent asset manager does the active allocation for you, says Manooj Mistry, UK head of db X-trackers, Deutsche Bank’s ETF division. T he traditional premise for investing in investors are happy to maintain beta exposure an ETF is to track the performance of a at low cost through investing in ETFs. Other market at low cost via a tightly investors, however, aim not just to track market regulated and liquid trading instrument. As performance but to generate returns beyond index trackers, ETFs are explicitly designed not that of the market. This type of above-market to provide returns above those provided by the performance is known as alpha. index. Rather, they are simply designed to be an ETFs can also be used to pursue alpha. However, efficient mechanism for delivering unlike traditional pursuers of above market to the investor the index’s risk and reward. returns, who engage in stock and bond picking, In investment circles, acquiring exposure to the alpha generation using ETFs is all about asset whole market in this way is referred to as taking allocation – being in the right market at the beta exposure. Many long-term, buy-and-hold right time, as opposed to being long the right underlying security. Focusing on asset allocation as the main driver of investment performance as opposed to company stock or bond selection constitutes a modern alternative to the traditional asset management approach. There is compelling evidence to suggest this could be a good way to generate alpha. Some academic research suggests that the majority of the variance in investor returns is determined by the overall choice of asset class invested in, rather than the individual choice of stocks or bonds. This may help explain why most active managers do not outperform markets consistently over time. db X-trackers, Deutsche Bank’s ETF platform, is the second largest ETF provider in Europe by assets under management. With over 200 ETFs to choose from, covering all major asset classes, investors can use db X-trackers ETFs to put together their own asset allocation portfolios. As a basic example, an investor seeking a globally diversified and asset class diversified portfolio, but with an allocation biased towards emerging markets, could combine long positions in db X-trackers ETFs on the FTSE