Exchange-traded Funds - ETFs
ETFs (exchange-traded funds) are investments funds which are traded on the stock exchange and track an index such as the DAX. The DAX consists of 30 major German companies that are traded on the Frankfurt Stock Exchange. The performance of the ETF investment funds develops in accordance with the DAX value development. The DAX ETF is the base value of the traded stock. Other countries also have a lead index, such as the CAC40 (France), Nikkei (Japan), FTSE (Great Britain) and the Dow Jones (USA). An index may be considered a stock market measurement that aggregates certain assets of the companies listed in the index. The index of the DAX ETF always develops in the same way as the stock index. The basic principle is that the DAX ETF rises when the underlying stock index on the stock market rises, and falls when the underlying asset loses value. Investors benefit from the development of the underlying asset up to 100 percent.
HOW ARE ETFS DIFFERENT FROM OTHER FUNDS?
The difference between ETFs and classical index funds lies in the fact that they can be traded on the stock exchange markets directly by the customers. By opening a trading account with a minimum deposit, private investors will gain access to the exchange market through services of online brokers. This makes it possible for investors to become independent traders and buy and sell fund shares faster. Fund companies don’t need to rely on their funds being actively managed by a funds manager because the illustration of the funds is relatively simple. Trading funds on the stock exchange market directly through an online broker saves money and is less complicated, because investors can react fast and independently on changing market conditions and can trade the funds during trading hours. In this regard, the rate fixing also plays an important role. Exchange-traded funds are traded on the basis of real-time prices, i.e. their price is continuously adjusted to the index of the underlying. Classically traded funds, on the other hand, don't react to volatile market movements and set the exchange rate only once a day. This means that investors can’t trade close to the market. ETFs are sold with a fee, termed agio. In this regard, the agio, spreads, pips and the bid and ask spread (0.05 to 0.5%) must also be taken into account.
It is now clear that passively managed funds are way ahead of actively managed funds, mainly due to fewer funds managers working towards outperforming their lead index and earn significant returns. In addition, they are often characterized by even higher management fees, which significantly reduce the investment return. An ETF, on the other hand, tracks its underlying asset 1:1 without funds managers taking an active role.
In addition to the popular lead indices, there are additional ways of investing in ETFs such as investing in ETF specific regions, countries or industries. Investment funds use the unlimited opportunities in order to place ETFs and break into niches. Investors have the opportunity to invest in individual sectors of the economy for which their own baskets and investment concepts are created, which reflect the underlying for the corresponding ETFs. A themed ETF is issued as a certificate. Closely related to this asset class are commodity certificates, with which investors can invest in commodities such as energy, oil, precious metals, coffee, grains or sugar. Regional ETFs track the stock indices of selected regions and countries. Investors participate directly in the performance of these equity markets with this asset class.
However, investors should have very good knowledge about the industry, market and country as these asset classes are highly dependent on the economic, political and social development of a country or industry. In addition, commodity ETFs are also dependent on uncertain factors such as harvest, resource extraction and natural disasters. Bond papers are issued in the form of government and corporate bonds. iShares of the investment company Black Rock and indices of MSCI, the financial services provider Morgan Stanley Capital Investment, are some of the best-known ETFs.
Despite its benefits, trading ETFs is also associated with risks. The market development can impact the funds performance of the investors negatively during falling markets. When the underlying fall at the stock market, they will also decrease the corresponding index funds, which can lead to a loss of the invested capital. With active funds, the funds managers can take measures in order to compensate for impending losses. However, with online trading platforms there is also an option of using a “stop loss” feature, which closes a position as soon as the account balance goes below a previously defined amount with possible losses impending. It should be noted that investors are advised to look into this issue in detail prior to investing. For as simple as the functional principle is, there are various ways to invest in ETF funds. Sometimes investment companies create complex financial products that have a speculative nature. These financial products are more suitable for professional and institutional investors who have a profound knowledge of the financial market.
A successful and long-term asset generation requires risk diversification. Investors should thus spread their risks by investing funds in different asset classes. The selection of individual funds and Exchange Traded Funds plays an important role. Commodity ETFs which rely on uncertain markets should only be considered as an additional option for the investment strategy.
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