Page 1

December 2012

An introductory guide to

Exchange Traded Funds


elcome to our special one-off magazine, Exchange Traded, which focuses on an asset class that has recently established itself as a front-runner in many individuals’ portfolio choices. We look at why Exchange Traded Funds (ETFs) have become increasingly popular, what intrinsically they are, and how you can find out more and invest in them. ETFs are index tracking funds that are traded on an exchange such as the London Stock Exchange. They combine the ready-made diversification of unit trusts with the simplicity of shares. The majority of ETFs are eligible for ISAs and attract no stamp duty. ETFs have some of the lowest annual charges of all collective investment schemes. But remember as with any investments the value and the


income from them may go down as well as up and you may not get back the original amount you invested. If you are unsure whether an investment is right for you, you should seek professional advice. Different ETFs may have specific risks, so make sure that the investment that you choose matches the level of risk you wish to take. Before investing make sure that you understand the associated documentation such as key features, risk factors, important information and product brochures. Our guest journalist, David Stevenson, explains how ETFs are structured, breaking them down into simple terms with his straightforward analysis, and later on examines the rise of ETFs and their background. Our round table discussion reveals the various strategies surrounding investment, with


How ETFs are structured

in this issue:

Exchange Traded round table


How ETFs are structured – the world of synthetics – David Stevenson examines the risks underlying ETFs.


The Exchange Traded Top 20s – Funds Alliance Trust Savings customers have been buying.


Growth prospects in emerging markets – HSBC’s view of which markets to focus on


How to buy an ETF or ETC with Alliance Trust Savings – Garry Mcluckie gives a step by step guide.

helpful insight direct from investment professionals. Guest experts provide their views in feature articles from HSBC, Deutsche Bank and Invesco PowerShares, whilst our article gives you the practicalities of investing in ETFs – a “how to” guide. I hope you enjoy this ETF special edition, and would like to hear from you about any other products or developments you would like further information about. Please send any feedback or suggestions to Garry McLuckie Marketing Director Alliance Trust Savings


Dynamic asset allocation


Exchange Traded round table – a discussion about ETFs with our panel of experts.


Dynamic asset allocation – Manooj Mistry of Deutsche Bank talks about the choices available with ETFs.


The Power of Fundamentals – Ravinder Azad of Invesco reviews the stock markets.


The ETF Boom – David Stevenson gives an overview of the ETF market.


The ETF Boom

Alliance Trust Savings Limited PO Box 164, 8 West Marketgait Dundee DD1 9YP Tel +44 (0)1382 573737 Fax +44 (0)1382 321183 Email Web


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 David Stevenson is a financial journalist and media entrepreneur. He writes the Adventurous Investor column for the weekend Financial Times and the Contrarian column for industry newspaper Investment Week. He’s also a regular contributor to the Investors Chronicle and has written a number of books on investing for the FT and Prentice Hall including the main reference book on ETFs.

David Stevenson Investment Columnist Financial Times

David was also a senior producer in television – working on a range of programmes at the BBC including The Money Programme and Tomorrow’s World - before setting up the successful corporate communications agency The Rocket Science Group. He’s now a partner in the web TV platform Watering Hole and is involved with helping media companies raise funding through the Coalition Partners investment group. In whatever spare time he has left, David is also a magistrate and he even finds time to edit his own investment newsletter called PortfolioReview.


n the good old days, investors looking to buy exposure to a major market like the FTSE 100 or the American S&P 500 had two simple choices – buy an actively managed fund that invested in the companies in this index, or buy the actual companies in the index as individual stocks. Plenty of investors have continued to stick with this traditional style of investing but a much cheaper and hugely popular alternative (in the USA at least) has emerged in recent years. This consists of investing in a fund that ‘tracks’ a major index such as the FTSE 100 or S&P 500. The actual tracking – as we’ll discover - is very simple to understand and involves the ‘fund’ manager (for it is a fund) buying the long list of constituent stocks in the index. The actual structure of the resulting fund will vary enormously with the big choice being between an unlisted, traditional unit trust or a

How ETFs are Structured | EXCHANGE TRADED

London stock market listed exchange traded fund (also known as an ETF). Just to confuse matters there are other fund and product structures with even more exotic acronyms which we’ll examine in a later article but for our purposes they are all simply ‘index tracking’ funds of one shape or another. Whatever fund structure you choose, as an investor you are simply ‘buying the market’ via an index. When compared to a traditional ‘active’ fund manager such as an investment trust there are three big differences. The first and most important is that you’ve decided to dispense with the services of a fund manager who will actively manage your investments based on their own views about the relative risks and rewards of a company in an index such as the FTSE 100 or S&P 500. That opens up the investor in an index tracking fund to a very specific risk which is that the index they are tracking might be full of absolute junk i.e. over-priced stocks that the market has chased up in value to ridiculous prices. But in dispensing with the services of an active fund manager, our ETF investor has also avoided a big risk, which is that the active fund manager has made wrong decisions about the companies they pick. Academics have endlessly studied fund manager returns over the last 50 years and they’ve concluded that most fund managers don’t outperform the ‘benchmark index’ such as the FTSE 100 and the S&P 500. With index tracking funds you are simply buying whatever the wider market is choosing to buy (as measured by an index) and doing away with the ‘idiosyncratic’ risks of opting for an active fund manager. Last but by no means least by investing in a fund that is passively managed (we use the term passive because there is no active fund manager but simply a plan to methodically buy whatever is in an index) you are cutting your costs very substantially. Many investment trusts still charge more than 1% per annum for their active management, whilst more than a few unit trusts charge well over 1.5% per annum. ETFs and index tracking unit trust funds rarely ever charge more than 1% per annum, with most charging a good deal less than 0.5%. That extra 1% of costs charged by active managers can add up to a huge amount over 10 or 20 years. What should become apparent is that the decision to invest in an index tracking fund like

an ETF is like anything else in the world of investment – there are some specific risks which we’ll talk about later in this article but also some big positives, namely lower cost, and doing away with the risk of trusting a fund manager to make lots of (hopefully profitable) trading decisions. More and more investors here in the UK are choosing to make use of ETFs and other index tracking funds as part of their diversified portfolios. The key is to understand exactly what you are buying into.

Investing in the FTSE 100 Index Let’s imagine that you have decided to invest in the world’s leading blue chip equity index, which is the American Standard and Poors 500 index. For whatever strategic reason you’ve decided that this benchmark index gives you the right exposure to the world’s leading, profit making companies. You’d thought about investing in the big stocks within the index – outfits like Apple and Exxon – but you decided that you wanted more diversification and didn’t want to take the risk of picking the wrong stocks. Which ETF to invest in? There are, as you can imagine, dozens of S&P 500 trackers, issued by a multitude of large banks and fund management groups. You decide – for right or wrong – to invest in the biggest of them all, in fact probably the largest ETF on the planet. This is an American listed ETF with the New York ticker SPY and it is managed by a huge fund management company called State Street.

What’s inside the ETF? What does the fund actually invest in? As you might expect, SPY invests in the constituents of the S&P 500 benchmark US index. In the table below State Street has listed the top ten holdings within the index tracking fund, with familiar names such as Apple, Exxon and Microsoft topping the list. Needless to say there are another 490 stocks above and beyond these top ten holdings. You’ll also see that against company is its weight within the index – in the SPY fund, shares in Apple comprises 4.8% of the total value of the fund. If we were to look at the composition of the index, there would be almost no difference whatsoever – the contents of the ETF would track (almost perfectly) the composition of the index.


“Whatever fund structure you choose, as an investor you are simply ‘buying the market’ via an index.”


EXCHANGE TRADED | How ETFs are Structured

“...we might begin to start worrying about something called the tracking error...”

Top fund holdings in SPY index tracker* Name

Weight (%)



Exxon Mobil




International Business Machines


Chevron Group


General Electric




Johnson & Johnson


Procter & Gamble


Wells Fargo & Co


* As of 21/8/2012

Understanding the tracking structure How do the ‘passive’ managers of this fund pull off this tracking? The simple answer is that they use lots of computing power to make sure that they constantly track the index via their fund, plus an active trading desk. If the price of a stock declines by 10% in value on one day, bringing its weighting within the index down from say 4.85% to say 4.4%, the fund managers at an ETF sell their holdings of this stock to make up the difference – and vice versa. The key to this particular index is that the managers are physically replicating the index i.e. if it says it’s in the index, the fund managers make sure that those actual physical shares are in the fund. That physical tracking is the norm in the US market and is very common here in the UK.

The synthetic tracker alternative But there is a newer alternative which involves a novel twist, called the synthetic tracker.

Physical tracking or replication is fine if one is tracking a very broad, very liquid, well known index such as the S&P 500 or the FTSE 100. These indices contain dozens of well known names traded in the world’s leading equity markets, where there are literally tens of thousands of professional institutions operating on a real time basis. But some indices aren’t quite as liquid, or ‘efficient’. These indices might track, for instance, Indian equities or track a very specialised bit of the UK mainstream equity space such as small cap emerging market stocks that pay a high yield. Within these specialised indices there may be all manner of complications – for whatever reason, physically tracking a specialist index might be a tad more complicated than tracking the FTSE 100. This needn’t prevent a fund provider from setting up a physical index tracking fund, but their management costs might be a little higher. Also we might begin to start worrying about something called the tracking error. This complex sounding term is actually very simple to understand as it involves measuring the returns from the underlying index against the returns from the fund. In some cases a big difference of as much as 1% a year might emerge. There are many reasons why this tracking error might emerge, not least those bigger management fees, but the net effect can be drastic. Imagine if your ETF was tracking an index and was supposed to have returned 5% last year but the fund actually only returned 3.5% – in this example our tracking error is 1.5%.

How ETFs are Structured | EXCHANGE TRADED

How does a Synthetic Tracker work? All this talk of tracking error and less liquid indices has spawned a rival to the physical replicating index tracking fund. This is called the synthetic tracker fund and in essence there is just one crucial change. A synthetic tracker fund following the FTSE 100, for instance, might do everything the same as its peer which uses physical tracking (or replication) but with the synthetic fund, its core holdings won’t be the stocks inside the actual index but what is essentially an IOU. The issuer might be a large investment bank that already holds all those stocks within the S&P 500 as part of its normal trading portfolio. The bank’s trading desk simply issues an IOU to the fund which says that they’ll promise to pay out on the return from investing in the index. As collateral they’ll issue what is called a swap (a kind of complicated IOU) which is that promise (measured against the return from the index) as well as collateral to back up the promise or ‘contract’. That collateral can come in many different shapes and sizes and could be whatever stock the bank holds within its trading portfolios at the time. How does this IOU work? For argument’s sake let’s imagine that our synthetic tracker is following the FTSE 100 over the next year. The fund starts with a market cap of £100m when the FTSE 100 index is at 5,000. One year later the index has gone up by 10% and the index level is now 5,500. Our fund should now be valued at £110m.

Behind the scenes the value of the swap and the associated collateral backing up this return has simply increased from a total of £100m (probably comprising £90m in collateral and a £10m swap contract) to £110m (£99m in collateral and £11m swap contract). The beauty of this synthetic tracking is that there need be no tracking error whatsoever and the issuer can also underwrite to pay out the total net return including dividends (once tax has been accounted for). Costs might also be substantially lower as a result and crucially, this synthetic swap is very efficient in dealing with less liquid markets such as Indian equities. The downside of a synthetic tracker should be immediately obvious. The investor is taking a risk with that IOU. It is in essence a gamble on the credit worthiness of the bank issuer, which introduces the concept of ‘counterparty risk’. The bank will do its utmost to mitigate that risk for you, by offering up that collateral. The regulators will also probably force the bank and the issuer to limit that exposure to the swap contract to 10% at most of the value of the fund. But there is no getting away from the fact you are taking a risk. As an investor you need to balance the potential reward of lower tracking errors, access to new markets and lower expenses with the downside of counterparty risk. The debate between physical and synthetic tracking has become very heated in recent years and many investors have what can seem like an irrational distrust of synthetic ETFs. There are pluses and minuses for both forms of tracking – investors simply need to understand the risks and make a considered judgement.


“As an investor you need to balance the potential reward of lower tracking errors, access to new markets and lower expenses with the downside of counterparty risk.”


EXCHANGE TRADED | How ETFs are Structured

Your checklist for using ETFs Is it an exchange traded fund or a unit trust? This is perhaps the most basic issue for many private investors. Most of the index tracking funds on offer are shares based funds that are ‘listed’ on an exchange, and thus the acronym used to describe them starts with an E, as in exchange. That means you’ve got to buy and sell through a stockbroker, who can deal in real time – although there will also be a bid offer spread between the asking and selling price. Many investors don’t have accounts with stockbrokers but use an adviser who might not even have access to a dealing platform. If this is the case they’ll probably use an index tracking unit trust fund or OEIC where the fund is structured in almost exactly the same way as an exchange traded fund but with dealing on a daily basis. Counterparty risk – how big a problem is it? Exchange traded notes and certificates have an obvious risk – they are in effect an IOU by a large financial institution, a form of securitised derivative. But that risk can also be overstated and can blind investors to the advantages of using synthetic replication. Investors also need to remember that all listed products – funds, notes and certificates – are not covered by the Financial Services Compensation Scheme (FSCS). Invest in any exchange traded fund at your own risk – the government will not bail you out.

“It’s important to note that this stock lending is carefully managed and monitored – you need to make your own decision if you are happy with the procedures and the collateral on offer.” actually own. The borrower of stocks and bonds in an iShares ETF portfolio will obviously have to pay a fee for the duration of the loan. They’ll also lodge ‘collateral’ in return which can amount to as much as 145% of the value of the loan in some isolated cases and more than 100% of the value of the loan in nearly all other cases. Stock lending is a perfectly acceptable practice – many actively managed funds also engage in securities lending – nevertheless there is still potential for concern with this stock lending. What happens if the borrower of shares in the fund goes bust? How easy will it be to grab back and sell any collateral offered up by that borrower? Yet it’s also important to note that this stock lending is carefully managed and monitored – you need to make your own decision if you are happy with the procedures and the collateral on offer. How liquid is the ETF?

Stock Lending activity – how much goes on and who benefits? If you do invest in a physical tracker you’ll probably be confident that your counterparty risk is very low, as your fund manager owns that big basket of shares you are tracking. But there is another risk that you need to be aware of based around something called stock lending. Those physical baskets of liquid assets represent a real opportunity for a sophisticated organization like iShares and its parent Blackrock – why not lend out the share and bond certificates within its portfolio for limited periods of time to external organizations who might to borrow them? The ‘borrowers’ are likely to be hedge funds or bank trading desks who might have a particular view on a company (bearish or bullish) and want to make a quick profit by speculating on stocks and bonds they don’t

ETFs have become very popular in Europe, with trading volumes exploding in recent years. But that liquidity can also be a curse as markets stress or liquidity seizes up. Markets-makers may choose to expand the bid offer spread on lightly traded ETFs to unacceptable levels – these spikes in bid offer spreads can also move around on an intra day trading basis. These excessive bid offer spreads also point to a bigger challenge – exchange traded products of all shapes and sizes may be the big new thing in Europe but that listing activity hasn’t always translated through into actual ‘action‘ on exchange – many European ETFs, for instance, boast low Average Daily Volume (ADV) numbers. Opinions expressed are those of David Stevenson, not Alliance Trust Savings Limited. Please read the important information at the end of this publication.



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.




iShares FTSE 100


ETFS Physical Gold


iShares S&P 500


ETFS FTSE 100 Super Short Strategy


iShares Markit iBoxx Corporate Bond Ex Financials


iShares Index Linked Gilts


iShares Markit iBoxx Euro Corporate Bond


iShares Markit iBoxx £ Corporate Bond


iShares Physical Gold


iShares treasury Bond 1-3


db X-trackers FTSE 100 Short Daily


iShares Dow Jones Emerging Markets Select Dividend


iShares $ Emerging Markets Bond


ETFS Physical Silver


iShares FTSE UK All Stocks Gilt


iShares FTSE 250


iShares FTSE UK Dividend Plus


db X-trackers MSCI AC Asia ex-Japan


SPDR Euro S&P $ Dividend Aristocrats


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.



EXCHANGE TRADED | HSBC Global Asset Management

Growth prospects in markets are still stro

which markets to At a time when developed market countries seem to be forever embroiled in debt crises, hindered by lacklustre economic data and beset by volatile equity markets, the emerging market bloc continues to show remarkable resilience. In truth, a new world order seems now to be forming, with the US, once the undisputed king of the global economy, seeing its crown being slowly usurped by China.


t a broader level, emerging nations have undoubtedly risen like a phoenix from the ashes of their own disasters, such as the Russian financial crisis of 1998. Today, emerging markets are the engine of global growth; while Western economies stagnate, countries such as Brazil, Russia, India and China (termed BRICs) continue to grow. At HSBC, we believe that these economies are likely to be the driving force of the new global economy. In our opinion, they offer attractive investment opportunities, for the following reasons. First of all, the BRIC economies have, to varying degrees, shown rapid economic growth, increasing market size across all sectors. They also have a burgeoning middle class, providing a rich source of potential consumption. Each of the BRIC countries also has multiple and different attributes and, thus, each is distinct. Brazil, the fifth-largest country by area and population in the world, has a wealth of mineral reserves and a focus on energy resources, commodities and agriculture. Russia is the world’s largest country in terms of territory, with a consumer market of over 140 million people, vast natural resources, a highly educated workforce, and technologically advanced research and production capabilities.

HSBC Global Asset Management | EXCHANGE TRADED

India has the second-largest population in the world with a young and vibrant workforce. The Indian economy benefits from specialisation in services, outsourcing, technology and pharmaceuticals. China, with 20% of the world’s population, is the most populous in the world and has raced up the GDP ladder in the last decade. Indeed, China is one of the fastest-growing economies in the world with an annual growth rate in excess of 10% over the last 30 years. In early 2011, it surpassed Japan 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 goods and is a leading global manufacturer across a wide range of industries, facilitated by its abundant labour resources.

n emerging ong –

to focus on Furthermore, BRIC countries have compelling long-term growth potential. The sustained growth of BRIC economies has been based on a combination of demographic factors, increased industrialisation and a wealth of natural resources. The pace of growth has seen their international significance increase rapidly, challenging the traditional economic dominance of developed markets. Recent growth has been driven by domestic rather than export demand, reducing BRIC reliance on their developed markets trading partners. The outlook for BRIC nations is also promising. Growth rates in the BRIC countries are widely expected to exceed those of western markets, especially China and India. Their stronger outlook has been a key reason for the large investment inflows seen in recent years.

The four countries also complement each other. China, as one of the leading manufacturing countries in the world, depends on the importation of commodities and energy from Brazil and Russia. Meanwhile, India provides the IT services that make it possible to optimise the use of new technology. The continued requirement of commodities from Brazil and Russia will help boost the economies of both countries. Meanwhile, India and China have benefited from the recent global economic crisis, as they are net importers. Overall, these factors make the BRIC bloc compelling from an investment standpoint. 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’s 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 first 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 accessible markets. HSBC’s physically replicated Russian ETF tracks the MSCI Russia Capped Index, which represents the top 85% by market capitalisation of listed companies in the Russian investable equity universe. The tracking of this index ensures the ETF is highly correlated with the Russian market. Furthermore, the fund has so far has delivered better tracking-error difference than most swap-based ETFs since its launch date. By harnessing all of HSBC’s capabilities, we have been able to manage both Russian equity and broader emerging market ETFs on a physical and competitive basis that 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.



EXCHANGE TRADED | Alliance Trust Savings

How to buy an ETF or ETC with



You may be considering what the next steps are before deciding whether or not to become an ETF/ETC investor.


he process really is the same as prior to purchasing any investment and the key is always do your research. Why? As well as being aware of the potential benefits of any investment you have to be fully aware of the risks and how much risk you wish to take. Only by conducting thorough research can you make an informed decision, fully aware of the risks and understand how much risk you are willing to take of both the risks and benefits of the underlying investment. At Alliance Trust Savings we understand the value of research in the investment decision process. We offer all our customers free access to research services from Morningstar, a recognised player in investment research expertise and facilitation. You can access information from Morningstar on our website by clicking on the Investment Selector tab at the top of our home page and then follow the instruction on that page which will take you to the tool itself, or alternatively it is available when you login securely to your account. In terms of ETFs and ETCs Morningstar holds a wealth of information for you to consider.

By clicking on the ETF tab (see table 1), you are taken to the main Morningstar page which contains a snapshot of information. This page is your ‘hub’ to access more detailed information on the ETF/ETC of your choice. The snapshot page is a good way of finding your feet and allows you to search by category if you’re interested in a particular sector. By using the drop down menus you can look at specific ETF companies and their sectors such as Emerging Markets or Commodities. Once you have selected a company you can view a particular investment by simply clicking on the investment name, which will then provide access to more detailed information on your chosen investment. You can also use the search box and input the ETF name or Investment Symbol to find a specific investment. Once you have selected your chosen investment you can view information via the navigation on the left hand side (see table 2). In the next section of this article we will look at how you can purchase an ETF online with Alliance Trust Savings. If you decide to purchase an ETF or ETC with

Side bar menu from table 2 (opposite) 1. Overview – Provides high level information including Morningstar category, performance history, key stats, ISA eligibility and Inception Date. 2. Chart – Growth of £1,000 across different time frames 3. Performance – Performance history tracked against an index. Also gives annual, trailing and quarterly returns 4. Risk and ratings – Morningstar risk rating measured against category and return/risk analysis

5. Portfolio – Includes information on market cap, prospective earnings, dividend yield factor, historical earnings growth and asset allocation. ETFs/ETCs invest in specific sectors and therefore asset allocation will typically be 100% equities for example within a specific region or 100% in a specific region. 6. Management – Contact information of the ETF/ ETC provider. Domicile, Legal structure, and whether or not the investment is a UCITs is also covered in this section. 7. Fees – Includes any fees and expenses that you will incur when buying into an ETF.

Alliance Trust Savings | EXCHANGE TRADED

logging in click on the Trading Centre tab and then click trade now. It is important to note that you cannot purchase an ETF/ETC within the fund supermarket. If you have ever purchased an equity with Alliance Trust Savings online the process is exactly the same for ETFs/ETCs.

Alliance Trust Savings you will be asked to confirm that you have read the relevant Key Investor Information Document (KIID) before completing the purchase. The KIID is really useful and provides important information. The good news is that you can access KIIDs again through the Documents tab of Morningstar. The information contained within the KIID is required by law to help you understand the nature and the risks of investing in the ETF/ ETC. A KIID will only be provided where the investment is classified as a UCITs.

How to purchase an ETF/ETC with Alliance trust Savings

To help you we have produced a list of all the ETFs/ETCs available on the Alliance Trust Savings platform and importantly the Investment Symbol that applies as you will need this for any purchases or sells. This full list is available within the ‘forms and documents’ section of our website under Formal Documents. This list will also help you with your Morningstar Research as some investments displayed on Morningstar are not available on our platform.

Once you have completed your investment research and decided on which ETF/ETC to purchase the easiest way to complete your purchase is online using our secure trading platform. To purchase an ETF or ETC after

We hope you have found this short guide to ETF/ETC research helpful. Our website has a range of ‘how to videos’ one of which is about purchasing an ETF or ETC online – why not check it out? Happy investing.

There is much more information available and too much to cover here – Why not log into your account today and find out more?


Investment Information News/Commentary


UK Equities

Int. Equities

Investment Trusts



ETF Quickrank

Enter name, ISIN or ticker

Garry Mcluckie Marketing Director Alliance Trust Savings

Garry joined Alliance Trust Savings in October 2010. His role is to manage the Alliance Trust Savings product and marketing strategy.

Morningstar Tools

Invesco Powershares Capital Mgmt LLC

All Morningstar® Categories

Enter name, ISIN or ticker

Snapshot Name


Short Term

Performance Morningstar® Category

Portfolio Morningstar RatingTM

PowerShares FTSE RAFI All-World 3000 Fd GBP PowerShares Dynamic US Market Fund

Global Flex-Cap Equity Not Rated US Large-Cap Blend Eq...

PowerSharesEQQQ Fund GBP

US Large-Cap Growth E...

PowerShares FTSE RAFI AsiaPac x-Jpn Fund G... Asia-Pacific ex-Japan E...



PowerShares FTSE RAFI Dev 1000 Fund GBP

Global Large-Cap Value...

PowerShares FTSE RAFI Dev Eur Mid-Sm GBP

Europe Mid-Cap Equity

PowerShares FTSE RAFI EmergingMrkts Fund... PowerShares FTSE RAFI Europe Fund GBP PowerShares FTSE RAFI Hong Kong China Fd...

Hong Kong Equity

PowerShares FTSE RAFI UK 100 Fund PowerShares FTSE RAFI US 1000 Fund GBP PowerShares Global Agriculture Fund GBP

Fees & Details YTD Total Return Expense % Ratio%

Not Rated

6.01 10.93

Documents Last Close

0.50 0.75

846.75 568.13


















Global Emerging Market... Not Rated





Europe Large-Cap Valu...









UK Large-Cap Value Eq...





US Large-Cap Value Eq...





Sector Equity Agriculture





Not Rated

Contact: For more information, please visit our website

Investment Information Morningstar® Fund ReportTM


Performance History


Growth of 1,000 (GBP) 1,406 1,332 1,258 1,184 1,110 1,036 962 2008 Fund +/- Cat +/- Cat -

Risk and Rating Portfolio Management Fees Print Glossary

Morningstar Tools

db Physical Gold ETC XGLD




2009 -


2010 -

2011 2012 - 12.1 5.8 - 15.0 3.6 -

Category: Commodities – Precious Metals Index: –

Trailing Returns YTD 3 Years Annualized 5 Years Annualized 10 Years Annualized 12 Month Yield Tax Year Return

Screens for illustration purposes only. Source: Morningstar

Key Stats Morningstar® Category Commodities – Precious Metals IMA Sector -

Morningstar RatingTM Not Rated

NAV 30/10/2012 USD 169.81

Day Change 0.64%

Total Net Assets (mil) Annual Management Fee 0.29%

Total Expense Ration Inception Date 15/06/2010



ISIN GB00B5840F36

Benchmark 31/10/2012 Fund 5.84 -

+/-Idx 0.00 15.78%

Fund Benchmark

London Fix Gold PM PR USD Morningstar® Benchmark


The value of investments and the income from them may go down as well as up and you may not get back the original amount you invested. If you are unsure whether an investment is right for you, or you are unfamiliar with the terminology, you should seek professional advice. Past performance is not a guide to future performance.



ROUND TABLE David Stevenson chairs a discussion about Exchange Traded Funds with a panel of experts: Nick Blake, Jose GarciaZarate and Manooj Mistry. This round table event was filmed at the Tate Modern, London on 5 September 2012. To view the full discussion visit

David: Why would ordinary investors invest in index-tracking funds? Why would they not go off and invest in investment trusts or a standard unit trust? Jose: I think one of the key things about the philosophy behind passive investment, is acknowledging the inability of active managers to comply with their objectives. There are a lot of studies that show over the long term, that active managers are unlikely to fulfil their investment objectives.


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 the active managers are not good at what they do, or that the rationale behind picking a certain stock or a certain bond is not correct at the time, it’s basically measuring the performance over a long term period which is what investors should be interested in.

David: What should investors really focus on? Manooj: When you look at an ETF it is essentially the index-tracking fund listed on an exchange and it trades like any other listed security so in the same way as with an investment trust you buy it on the exchange through your broker you can do the same with an exchange traded fund. From a regulatory perspective ETFs are regulated as any other OEIC or unit trust, they conform to what’s called the UCITS Regulations a pan-European set of regulations that govern funds across Europe and you’ve also got the other ETPs Exchange Traded Products categories out there so you’ve got Exchange Traded Commodities which are known as ETCs and typically these will give you exposure to single commodities or a basket of gold or oil for example and then you also have other products called Exchange Traded Notes and these tend to be linked, once again could be linked to commodities but could also be linked to strategies such as volatility.

If you look at it from a regulatory perspective an ETF is the most highly regulated product, an ETC is basically issued by a special purpose vehicle and it trades like a security on the exchange and an Exchange Traded Note is typically a debt security issued by a bank.

David: One of the most shocking things is that the average fee charged by average fund in Britain is actually going up not down over the last few years and that’s across the entire universe of funds, but how do ETFs or unit trusts compare in terms of cost? Nick: That’s the challenge for investors, it’s knowing in advance who will beat the index and that’s the real challenge. Now, as to the different types, certainly in our view an Exchange Traded Fund, an index exchangetraded fund and a mutual fund is actually the same vehicle, it’s just a different way to buy the same exposure in that way, typically investors would find that an index fund or an ETF would typically be much lower cost than an active fund and that’s because active funds put a lot of effort into research trying to outthink the market, trying to do the deep research to understand how they might out-perform the market, an index fund isn’t trying to beat the market, it just buys for example everything in the FTSE 100.

“The challenge for investors is knowing who will beat the index.” Nick Blake



David: How much would an average index-tracking one charge? Nick: The usual sort of apples and apples comparison trouble here is that some of the active funds include commissions and fees in them whereas many index funds don’t pay commission and fees but on a like for like basis an index fund would typically be half a percent to three quarters of a percent cheaper than an active fund in general and as you say the compound effect of those charges could be quite significant. Jose: We ran a study at Morningstar about the implications of high management fees and it is astonishing how much of your long term returns can be eaten away by paying management fees. At 1% or 2% this doesn’t sound like a lot, but this is compounding year after year. Manooj: It’s very much like what we see is that ETFs give retail investors the same tools as institution investors have, institution investors have been using passive products for many years.

David: Because a lot of people have pension funds, would pension funds make use of index tracking? Jose: They do because this is one of the key industries where you really need to make sure that the stream of revenue is more or less secure and it is one of the key reasons why I think the ETF market is actually kicking off with some important growth rates in places like the UK where you have a very important pension fund industry.

Gold is purely a safe haven strategy borne out of the uncertainty in the global economic picture and people are looking to protect capital. It’s not so much that they’re seeking to have positive returns but at least preserve the capital and on the fixed income space you see a lot of interest in corporate bonds Manooj: The reason why you can offer a single commodity exposure to something like gold is that the vehicles that the products are issued by are vehicles that aren’t as regulated as funds, they are regulated as special purpose vehicles which have the opportunity to issue debt or securities linked to one asset so they’re not subject to the same diversification rules you have in funds.

David: So they’re a little bit riskier in their structure. Manooj: Yes but a lot of these products for example the gold products are called a whole physical – gold, tobacco products.

David: It might be safer in some respects. Manooj: What you typically see with an exchange traded commodity is that gold is held in a vault somewhere backing that investment so these products are backed by the actual gold bars sitting somewhere so these products are what I would call collateralised or asset backed they’re physically backed by assets.

David: What are the kinds of things that people are buying out there at the moment?

David: And that’s a crucial thing because when we talk about commodities in fact you sort of have to go down that route don’t you because quite often they’re either physical holdings or they’re futures or they’re done on options exchanges so they can’t be held in the traditional way that an equity fund would hold, you just can’t do it that way can you so that’s the reason they’ve done it that way.

Jose: Well lately it’s been about a search for yields and trying to find the safest investments. So, you have the fixed income space gathering a lot of investors’ interest, and you have a commodity space of the ETFs.

David: What’s the big difference in this physical versus synthetic debate, what’s going on there? It does sound very confusing for many of us.


Jose: I think the first thing is to define is ‘what is a physical and what is a synthetic fund’. Physical is pretty easy to understand. The fund is either going to hold all the components of the index or a subset of the components of the index. Synthetic providers or synthetic ETFs deliver the return of the indices via small contracts. The key difference obviously in the structure is that a synthetic ETF will always have a counter party risk, that’s the nature of the structure because a counterparty, typically that is when an investment bank will have to provide the return of the index and there is always the risk even though theoretical that the bank will not be able, for whatever reason, to provide that return.

David: Manooj you do synthetic so just talk us through how you structure a synthetic fund. Manooj: Jose has explained the first part in terms of how the fund works, the fund is entering into a contract with a bank to deliver the underlying index performance then as part of that contract the fund also needs to receive some physical assets so this physical collateral is there to basically offset the counter party exposure. The amount of assets that need to be delivered or posted with the fund is determined by the regulations, by the UCITS

Regulations I mentioned earlier so as a minimum a fund must at least have 90% assets. In many cases in the ETF industry many providers are actually doing what is called over collateralisation so they’re actually assets greater than the value of the fund so these are basically an element of a cushion of security there.

David: To the outside observer who is used to traditional fund structuring, what are the advantages of doing it this way? Manooj: The advantages of synthetic replication or swap based replication is that you can deliver the index performance without any tracking error / difference. This means that you can guarantee that your returns will be the FTSE 100 index minus the management fees.

David: And to understand the tracking error, it’s very simply an idea which is that you say you’re going to track the FTSE 100 and it turns in 10% one year and you only turn in 9%, your tracking error will be 1%. Manooj: 1% yes and some of that 1% will obviously be the management fee but there could be additional tracking error on top of that.


“ is astonishing how much of your long term returns can be eaten away by high management fees year after year...”

Jose Garcia-Zarate



David: So Nick you do a physical approach and that sort of does what it says on the biscuit tin really you buy the FTSE 100, you buy the bunch of stocks in the FTSE 100, what are the advantages of that approach do you think?

slight tracking error and a good adviser and good investors really look for weighing off those trades around counter party risk versus perfect tracking.

Nick: Both methodologies (Synthetic and Physical) achieve the same outcome for investors and both are covered by the European UCITS Rules. Our preferred approach is physical, we like to own the securities and deposits that are there backing up the return for investors. One of the challenges with physical is, as the funds get broader, so let’s say you’re trying to track a more global index.

David: How does that work? I’ve heard things like stock lending, what’s going on there? What’s that all about?

David: You hear things like the MSCI World. Nick: Correct, and that might require you to own thousands of stock. And there could be a point of inefficiency where trying to own a very small amount of a very obscure opportunity means it’s inefficient for the fund manager to own that so whilst most physical managers will get as 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 occur so really the trade-off for investors here is with synthetic you get a certainty of return because you have the promised return but have counter party risk versus no counter party risk with physical but potentially a

Manooj: You can get counter party risk with the physical replication to a certain extent

Jose: There could be counterparty risk in physical funds.

David: How does that work, surely if Nick has his 100 stocks, his FTSE 100 he’s got them in his safe and he has the certificates, what’s wrong with that then, what could go wrong there? Jose: The thing that could go wrong is that if he decides to actually lend those 100 securities to other parties then obviously you create an element of counterparty risk in the sense that those other parties might not return the securities to the fund. Not all physical funds engage in securities lendings but a lot do.

David: What’s an interesting area out there that investors should just keep an eye on, where there’s a lot of activity going on? Manooj: I think what we’re seeing is that with ETFs retail investors have the same tools as



institutional investors have and what we’ve already seen is a number of institutional portfolio managers using products like ETFs and index funds in their portfolios and they’re using these products to do asset allocation so rather than choosing individual stocks or bonds, they’re actually deciding OK I want exposure to a particular market or asset class. Nick: The thing I’m most pleased with actually is not so much in the strategies themselves but more in the access that investors have to these strategies so there was a time when low cost products wouldn’t be carried by many of the platforms out there because quite frankly they didn’t pay a commission being very low cost so investors really only had the choice of some relatively expensive funds and things like investment trusts or ETFs or no load mutual funds typically wouldn’t be carried but one of the developments I’m delighted to see more forward thinking platforms like Alliance Trust are making the access to these vehicles far wider now than has ever been before so investors have got far more choice and they’ve also got choice in how they index so in many ways an ETF is just another way to index like a mutual fund but how they index can also have an impact on cost as well, accessing these through a stock broking platform might be a cheaper way to go than accessing them through a traditional funds platform and investors should think about not just the cost of the fund itself but also the cost of ownership of the fund just as much because both of those costs will erode their returns over time so one of the things I’m delighted to see is just the

broader access to these vehicles, better disclosure, more transparency just so that investors have a far more informed way of looking at their portfolios. Jose: Perhaps it is the pending revolution for the ETF market, the accessibility and the extensive use of Exchange Traded Products by the retail community. I think that socially the conditions are right for an increased participation of the retail community because people have to save money for things such as pensions and university costs.

“...investors have got far more choice and, also in how they index...” Nick Blake

This article is for information only. The views stated in the discussion are those of the panel members at the time, and not Alliance Trust Savings Limited. Please read the important information at the end of this publication. Investments can down as well as up and capital is at risk so that investors may get back less than they originally invested. Investments in emerging markets may involve a higher element of risk due to less well-regulated markets and political and economic stability. Exchange rate changes may cause the value of underlying overseas investments to go down as well as up. Whilst care has been taken in compiling the transcript of the discussion, no representation or warranty, express or implied, is made by Alliance Trust Savings Limited as to its accuracy or completeness. Nothing contained in this transcript of the discussion should be construed as being an invitation or inducement to engage in investment activity. No advice is given by Alliance Trust Savings Limited. For advice on investing, please consult an independent financial adviser.


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.


he traditional premise for investing in an ETF is to track the performance of a market at low cost via a tightly regulated and liquid trading instrument. As index trackers, ETFs are explicitly designed not to provide returns above those provided by the index. Rather, they are simply designed to be an efficient mechanism for delivering to the investor the index’s risk and reward. In investment circles, acquiring exposure to the whole market in this way is referred to as taking beta exposure. Many long-term, buy-and-hold

investors are happy to maintain beta exposure at low cost through investing in ETFs. Other investors, however, aim not just to track market performance but to generate returns beyond that of the market. This type of above-market performance is known as alpha. ETFs can also be used to pursue alpha. However, unlike traditional pursuers of above market returns, who engage in stock and bond picking, alpha generation using ETFs is all about asset allocation – being in the right market at the 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

Deutsche Bank db X-trackers | EXCHANGE TRADED

All-World Ex UK, the iBoxx £ Gilts Total Return Index, the DBLCI – OY Balanced ETF (GBP) – which provides broad commodity market exposure – and the MSCI Emerging Markets TRN Index ETF, with a heavy weighting towards the latter. (Note that this is a hypothetical example only. Investors should seek professional advice before trading.) For investors who do not wish to actively manage their own portfolios, but like the idea of potential alpha generation through active asset allocation with ETFs, there is another alternative. In February, db X-trackers launched an actively managed ETF that uses asset manager SCM Private to allocate an underlying portfolio of exchange-traded products. The db X-trackers SCM Multi Asset ETF invests in a portfolio of ETFs and exchange-traded commodities (ETCs) with the goal of using asset allocation to accumulate returns significantly ahead of inflation. Key attributes of the ETF are: • Multi Asset – the fund invests in a wide range of Deutsche Bank ETFs and ETCs to gain significant diversification and liquidity at low cost. • Actively managed – the weightings/asset allocations are actively managed on at least a monthly basis by SCM Private and may be all equity, all bonds or all cash. • Investment in indices – the fund will invest solely in indices in order to produce more diversification and less volatility. • SCM is a fund manager with a proven track record over many years – chief investment officer Alan Miller has an exceptional record as a successful fund manager with over 22 years’ experience in many different investment vehicles ranging from pension funds, investment trusts, unit trusts and hedge funds. • Low cost – the db x-trackers SCM Multi-Asset ETF has an all-in fee of 0.89% pa. This compares favourably with an average total expense ratio (TER) (annual operating costs including underlying fund costs) for a fund-of-funds investing into externally managed equity funds of around 2.47%*.

• Transparent – the full portfolio including all underlying holdings is published daily on the internet. By being highly diversified – through being exposed to a range of ETFs and ETCs, which themselves track the performance of a large number of constituent securities – the db X-trackers’ multi-asset ETF aims to deliver stability in total returns while managing volatility. The product combines the positive elements of ETFs, such as being relatively low cost and transparent, with active management performance. It is a straight forward and modern alternative to traditional discretionary funds.

Product Information db x-trackers SCM Multi Asset ETF All-in Fee/TER


Trading Currency Exchange Code ISIN


UCITS IV Complaint


ISA/SIPP Eligible


Investors should note that db X-trackers ETFs are not capital protected or guaranteed and investors in each db X-trackers ETF should be prepared and able to sustain losses of the capital invested up to a total loss. The value of an investment in a db X-trackers ETF may go down as well as up and past performance is not a reliable indicator of future performance. Please consult your financial advisor before you invest in a db X-trackers ETF since not all db X-trackers ETFs are suitable for all investors. A comprehensive list of risk factors is provided on www.etf. For further information regarding risk factors of a specific instrument, please refer to the risk factors section of the prospectus, or the Key Investor Information Document. * Source: Lipper, Investment Life & Pensions Moneyfacts, July 2011.

This article has been issued and approved by Deutsche Bank db X-trackers.

Manooj Mistry UK Head of db X-trackers Deutsche Bank

Manooj Mistry, UK head of db X-trackers: 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.



EXCHANGE TRADED | Invesco PowerShares

The Power of Fu Many investors have arguably been disillusioned by the apparently dismal performance of stock markets globally over the past decade, however, scratching the surface shows that there were many stocks that have done fairly well, and indices that have avoided sharp falls and in fact, have actually posted gains.

Ravinder Azad Listed Fund Sales Executive Invesco Asset Management Limited

Ravinder Azad has over 13 years’ experience in asset management, of which almost eight have been spent in Listed Fund Sales. He has been instrumental in the launch and on-going promotion of the Invesco PowerShares UK Exchange Traded Funds business. Ravinder passed the IMC in 2000 and is a member of the CFA Society.


he FTSE 100 Index is constructed by initially ranking all UK listed securities by their market capitalisation, arrived at by multiplying the number of shares in issue by the current market share price. The largest 100 stocks from this formula make up the FTSE 100 Index we see in the financial pages of the national newspapers. Since the launch in the United States of the S&P 500 Index as the first market capitalisation weighted index in 1957, the global investment community has embraced market-cap weighting as the methodology underlying the majority of modern market indices. Quite literally, market-cap weighting is the popular choice and has been broadly accepted as the standard way to measure equity markets. Market-cap weighted indexing means the market dictates the selection of and the weighting that a stock receives in an index. This is problematic because market speculation can cause significant mispricing of stocks which, in turn, can result in what we believe to be disproportionate weightings in that index. A good example of this phenomenon occurred during the 1999-2000 ‘tech bubble’, when we saw internet company share prices surge as a result of the future perceived growth these companies were expected to generate in this new tech-savvy era.

Issued and distributed in the UK, on behalf of Invesco PowerShares, by Invesco Asset Management Limited. Registered Address: 30 Finsbury Square, London EC2A 1AG. Authorised and regulated by the Financial Services Authority.

As the share price of some of these companies took on an almost vertical trajectory, traditional indices based on market-cap found their weightings in such stocks were becoming larger and larger – keeping in mind that these indices are derived from the market capitalisation of a company, which is linked to the share price. If the share price increases and in turn its market capitalisation, then its weight within an index increases too.

Market-cap weighted indices do not usually provide an accurate representation of the state of an economy, but they do mirror the volatility of stock prices. The market price of a stock can be significantly inflated by the perceived future growth prospects of the underlying company which, as we saw during this tech-bubble, can be overly optimistic, incorporate unknowns and therefore be prone to inaccuracies. As a result, the underlying economic size and strength of a company cannot be determined with any real accuracy by reference to its position in a market cap-weighted index due to possible market speculation and mispricing.

A smarter way to access the market Fundamentally weighted indices could be viewed as being essentially a modernisation of cap-weighted indices. These indices use a fundamentals-weighted approach designed to assign index weights according to the financial considerations of a company, not its market capitalisation. Fundamental indexation relies on portfolio weights that are derived from company fundamentals (cash flow, book value, sales and dividends), rather than portfolio weights derived from the market valuation of shares in issue. We believe that these indices provide the opportunity to more accurately determine those assets with higher returns and lower risk profiles when compared to traditional cap-weighted indices or benchmarks. Some indices are constructed using only a single measure. At Invesco PowerShares, we believe in a balanced approach and look for those indices which incorporate a range of corporate fundamentals and therefore provide a more balanced picture of the financial quality and economic opportunity of a particular constituent company.

Invesco PowerShares | EXCHANGE TRADED

undamentals Fundamental measures can better reflect a company’s economic contribution In contrast to market-cap weighted indices, which mirror the volatility of stock prices, fundamental indices assign weights according to a company’s operating and accounting performance, helping to ensure what’s believed to be a more accurate representation of its internal economy in relation to its place in the index. Fundamental indices do not allow the market to directly dictate the weight a stock receives in an index so they are less likely to reflect stock market ‘bubbles’. This is because a constituent company’s revenues and dividends are not directly affected by share price speculation.

Fundamentally weighted indices • Are designed to identify the fair value of each company. • Utilise fundamental variables that do not depend on the fluctuations of market valuation. • Performance may be less influenced by stock market ‘bubbles’ as index member weights are not driven by share price volatility • Ordinarily avoid overweighting overvalued stocks – a potential shortcoming with market capitalisation-weighted indices.

More efficient indexing of an inefficient market • Cap-weighting has a rich history, but has definite shortcomings. • Fundamental indexing seeks to address these short comings while maintaining the benefits of a broad market index. It is therefore essential to understand the construction methodology behind the index that is being replicated by an Exchange Traded Fund.

Important information The price of ETFs and any income will fluctuate, this may partly be the result of exchange rate fluctuations, and investors may not get back the full amount invested.

Past performance is not a guide to future returns. When making an investment in an ETF, you are buying shares in a company that is listed on a stock exchange. Investments cannot be made directly into an index. ETFs’ share prices are subject to a bid/offer spread, subject to management fees, and whilst they seek to track an index, there is no guarantee that this will be achieved. Accordingly, ETF investment returns will be different to those of the index. Restricted investors: the information in this document is designed solely for use in the UK, and complies with regulatory requirements of this jurisdiction only, and is not intended for residents of any other countries. The distribution and the offering of ETFs in certain jurisdictions may be restricted by law. Persons into whose possession this document may come are required to inform themselves about and to comply with any relevant restrictions. This does not constitute an offer or solicitation by anyone in any jurisdiction in which such an offer is not authorised or to any person to who it is unlawful to make such an offer or solicitation. Persons interested in acquiring ETFs should inform themselves as to (i) the legal requirements in the countries of their nationality, residence, ordinary residence or domicile: (ii) any foreign exchange controls: and (iii) tax consequences which might be relevant. This document is intended for information purposes in regard to the existence and potential benefits of investing in ETFs. However, it is not intended to provide specific investment advice including, without limitation, investment, financial, legal, accounting or tax advice, or to make any recommendations about the suitability of the ETF for the circumstances of any particular investor. You should take appropriate advice as to any securities, taxation or other legislation affecting you prior to investment.




The ETF revolution is now truly global – in almost every part of the developed world new ETF providers are springing up and ETFs are even threatening to invade the developing world with new launches in places as varied as Botswana and Taiwan.


BOOM! By David Stevenson, Investment Columnist, Financial Times


auging just how successful this indexing revolution has become is fairly straightforward, as many of the leading issuers of ETFs such as iShares (now owned by giant US asset management firm Blackrock) and Deutsche Bank (through their DB X trackers unit) closely monitor the market, attempting to spot key trends and generally keeping a watchful eye on liquidity on exchange. At the end of June 2011 for instance analysts at Deutsche estimated that the global index tracking industry had reached assets under management of $1.4 trillion globally, with 22% (€216.4 billion) concentrated in European listed funds. The Deutsche analysts also reckon that looking at the most recent ten year period, over the past decade, the European

ETF industry grew [measuring assets] by thirteen fold (13.2x), while the US ETF market grew over six-fold (6.5x). These numbers represent extraordinary growth over the last decade – ETFs were virtually non-existent in Europe at the beginning of this new century and even in the US they were a tiny niche. Now ETFs are arguably the fastest growing part of the whole global asset management business. By the end of December 2011 the Deutsche Bank analysts reckoned that there were over 3,210 exchange traded products (funds and notes) of some sort globally – of that total of 3,210 products, 2,823 were ETFs and 387 either ETCs or ETNs.


Which asset classes are popular with ETFs? The table below from Blackrock gives us some idea of the key markets favoured by equity investors. Unsurprisingly equities of all shapes and sizes dominate the market although in flows into fixed income securities (bonds) as well as commodity funds has increased markedly over the last few years. What do exchange traded funds invest in?

Exposure as at Nov 2011 in US Billion Equity

YTD change in assets under management %

Market share %

AUM 1,067






Emerging Markets










-3.8 3.2

North America

Asia Pacific Global exc US



Global equity




Fixed Income
















now invest globally, in both conventional and inflation linked bonds, with issuers as diverse as low risk governments through to very high risk sub investment grade corporate. Crucially the income yields on offer vary hugely with low risk short dated government bonds paying as low as 1% (or even lower) through to high yield corporate bond funds paying out not far off 10%. Total expense ratios are also very low on these bond trackers, with no funds charging more than 0.50% and more than a few less than 0.20% pa. But investors also need to think carefully about investing in bond ETFs especially with risky issuers such as emerging markets governments and big corporates. Bond indices are deliberately weighted in their composition towards the largest bond issuers not the most reliable, credit worthy issuers. This means that an index in junk corporate bonds for instance is likely to have its heaviest weighting in the most traded, most liquid bonds which are likely to be issued by the most indebted companies. Might it not be better to invest in those issuers with the lowest risk levels and highest credit ratings as opposed to the most popular bonds?

Data as at end of November 2011 or where updated data is not available, we utilise the most recent period available.

Commodity ETFs

Source: BlackRock Investment Institute, Bloomberg

Small, specialist index tracking fund specialists such as ETF Securities have prospered hugely in recent years, helped along by a massive increase in funds allocated to commodity funds generally and precious metals in particular. To this day even though gold prices have stalled, big gold funds run by the likes of ETF Securities continue to experience massive inflows of as much as $1 billion every month. Investors worried by central bank intervention in the money markets are betting that eventually inflation will rear its ugly head, with largely uncontrollable results, sparking a massive increase in gold prices. These fears have pushed investors to pump money into ETCs that invest in what is called ‘physical’ allocated’ gold. These trackers allow an investor to buy an allocated share of actual physical gold held in large, secure gold vaults in London, New York and Switzerland. Charges are usually fairly low (well under 0.50% for the main funds) and most investors are re-assured by the fact that they own gold assets directly under the control of the fund managers, not a large investment bank.

The Big New Trends in ETF Land This analysis by BlackRock is enormously revealing. It shows that ETFs have become both popular and also diverse. Gone are the days when investors simply used ETFs to access a large and important stock market index such as the FTSE 100 or the S&P 500. This data suggests that in recent years investors have primarily been using ETFs as the building blocks for very diversified portfolios full of innovative strategies and markets. Bond ETFs Investing in bonds has become popular with ETF investors in recent years. Bonds have had a good decade compared to equities in terms of returns, so a big inflow of funds into bond ETFs shouldn’t be terrifically surprising. But that insatiable demand has sparked a huge increase in the variety of bond ETFs available to the private investor - you can


“Might it not be better to invest in those issuers with the lowest risk levels and highest credit ratings as opposed to the most popular bonds?”



“Investors worried by central bank intervention in the money markets are betting that eventually inflation will rear its ugly head.”

At the moment investor interest in more mainstream commodity ETCs has diminished, especially as Chinese growth slows down and industrial metal prices wane, although it’s also true that agricultural spot prices have shot up recently following the recent poor US grains harvest. But investor interest in commodities is bound to wax and wane over the course of the business cycle and talk of a global economic recovery will probably result in yet another surge of interest in commodity tracking funds - these ETCs invest in futures contracts for all manner of individual commodities ranging from a broad group of energy markets (including oil) through to individual trackers for copper or grains.

portfolios in a relatively intelligent, diversified way - they don’t just buy a few single company UK stocks and be done with it, but look to invest across different country markets as well as varying asset classes including bonds, gold and other commodities. This diversification means that investors will typically want to run diversified, multi asset portfolios which will evolve over time. Two key insights stand out from this observation – the first is that good diversification across asset classes makes absolute sense and in addition that as we grow older, our tolerance of risk changes very substantially, forcing us to change the composition of our portfolio.

Emerging Market ETFs

Imagine you are 20 years old. You are earning just enough money to put aside say £100 a month in a fund that you will stick with for the next 40 years of your working life, but for now you want lots and lots of growth in your underlying investments. That means you are willing to take on some risk – now – and the long-term data on returns suggest that the riskiest, most rewarding of the major asset classes are equities. Bonds, by contrast, are possibly a bit boring and safe and although you are probably never going to lose more than 20 per cent in any one year (that is called your maximum drawdown in the trade), equally you are never going to bag any huge tenbaggers that make your fortune. In summary, our 20 year-old thrusting young buck quite sensibly decides that his risk tolerance is high and that he wants to stack up on equity exposure and ‘go for it’ in terms of risk.

Many investors have woken up to the potential for solid, long term profits from investing in emerging and frontier markets. There are many, excellent emerging markets managers already operating in the investment trust sector for instance including Hugh Young at Aberdeen, Slim Feriani at Advance and Mark Mobius at Templeton, but the choice of funds is much bigger within the ETF universe and the costs are much lower. Fund managers such as HSBC have made a point of specialising in these emerging markets, offering ETFs with lots and lots of choice and very low fee structures (the vast majority of HSBCs product range charges less than 0.50% per annum) and also boast simple to understand physical tracking structures. Fundamental trackers A number of fundamental index tracking funds have also emerged in recent years – the key insight here is that some investors don’t believe that the market always put a sensible price on some unloved stocks. Some value investors would rather invest in an index where the constituents in that index are decided not by the manic mood swings of the market but by their fundamental value, using measures such as the dividend yield (higher yielding stocks are a bigger percentage of the index) or a combination of fundamental factors including the book value of the companies.

Flash forward 40 years. Our young buck is now a considerably older 60 year old and he knows that retirement is just five years away, so he needs to accumulate a large pot of savings capital to last him through to his twilight years - he could be living through until he is 90 years if current longevity studies are proved right. This means that capital preservation is all important to this investor. He absolutely cannot afford a capital loss or DRAWDOWN of something like 20 per cent in one year – that means he takes a very negative view of equities and he is a big fan of bonds.

Where are you in your life cycle?

How your investment tastes change as you get older

Perhaps the most important big new innovation in the world of index tracking funds is the simplest to understand – the multi-asset portfolio. Most investors now run their

This transition in both tolerance of risk and awareness of potential returns sits at the heart of what is called lifecycle analysis. Over those 40 years our private investor changes – both


physically and in his tolerance of risk – and over time that translates into a big change in their choice of assets. Early on our investor is sensibly interested in equities and probably no bonds, whereas in their mid 40s they are probably making the shift away from equities into some bonds and by the mid 50 our investor is probably biased towards bonds. The simple process of constructing a mix of assets that can be used as the building blocks of a single portfolio and can change over time, has evolved into something called the glidepath. The graphic below shows how this transition starts with high-risk assets, transitions through a balanced approach in mid life and ends with a mixture of assets with a bias towards bonds later in life.

How a glide path translates into a fund This blindingly simple analysis has evolved into something called a Risk Target fund. As we’ve already seen older investors are likely to be more risk averse, so they are by definition more ‘conservative’ in their outlook. Step

forward multi-ETF portfolios from the likes of Vanguard where the mixture of (passive) asset classes is labelled ‘Low Risk’ or ‘Conservative’. By contrast, our younger investor might be much more risk friendly, and be willing to ride out the volatile equity markets by investing in a ‘High risk’ or ‘Growth/ Adventurous’ portfolio. The key point is that in these target risk funds, all the equity, bond or alternative asset components for this diversified portfolio consist of different underlying ETFs or index tracking funds. The asset classes are then combined together to form a diversified, single portfolio which can be bought as a core investment. Crucially this single portfolio of ETFs or index tracking funds is usually very low cost (most multi-asset portfolios charge under 0.80% per annum, with some offering portfolios for less than 0.40%) and can be changed as the investor’s tolerance of risk changes over time i.e. as they get older they can sell their adventurous portfolio and opt for a more cautious, conservative “Low risk” portfolio.


“Transition in both tolerance of risk and awareness of potential returns sits at the heart of lifecycle analysis.”

The chart below shows a typical glidepath showing changing exposure over a number of years to bonds (lighter brown) and equities (darker brown), with range of different possible allocations indicated by dotted line. Asset Allocation (%)

Source: David Stevenson






0 40





15 Years until retirement






Opinions expressed are those of David Stevenson, not Alliance Trust Savings Limited. Please read the important information at the end of this publication.

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ATS12-422 (December 2012)

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