ETF Exchange Traded Fund

Transcription

1 ETF Exchange Traded Fund BM&FBOVESPA INVESTMENT FUND Eficiência. Efficiency. Transparência. Transparency. Flexibilidade. Flexibility. Em um In a único single investimento. investment.

2 What is an Exchange Traded Fund (ETF)? An ETF is an open-ended investment fund, with units traded on the market like any stock. The objective of an ETF is to track the performance of a specific index. To this end, its portfolio replicates the composition of its underlying index in accordance with certain rules established by applicable regulations. ETFs are also known as trackers. ETF: a recent success story The Exchange Traded Fund is an example of a rapid success story in the international market. The first ETF was launched in 1989 in the United States to reflect the performance of the S&P500 index. At the American Stock Exchange and Philadelphia Stock Exchange, ETFs traded under the name of Index Participation Shares. In the 90s, ETFs based on the TSE 35 and TSE 100 indexes were launched in Canada. In 1993, Standard & Poor s launched its Depository Receipt (SPDR), known then as Spider. In 1996, Barclays Bank (United Kingdom) launched the World Equity Benchmark Shares (WEBS), which were later called ishares MSCI Index Fund Shares. Since that time, these new forms of investment have become ever more present in the world s major financial marketplaces, such as Hong Kong, Germany, Japan, Spain, Singapore, Brazil and Mexico.

3 Did you know? ETFs are managed by fund managers and reflect the performance of a market index. Why invest in ETFs? What are their advantages? When investing in an ETF, the investor is also investing in a stock portfolio. In other words, when buying an ETF, the investor takes home a basket of stocks of different companies that together track the performance of a certain index, thereby reducing the probability and risk of loss resulting from the selection of a single security. In addition, the cost of investing in an ETF is lower than the cost of structuring a similar basket of stocks. This is due to the fact that, in order to invest in the stocks that make up an index, one must buy each stock individually in the same proportion as that utilized in the index, bearing the trading fees for each purchase. Furthermore, in order to maintain these proportions, the investor must actively manage the resulting basket of individual stocks. Another advantage is that the investor can purchase or sell an ETF on the secondary market like any other stock, or request the creation or redemption of an ETF, provided that the purchase or sale is made with the same securities that constitute the theoretical portfolio of the index to which the ETF is linked, pursuant to the specific regulations for each product.

4 ETF Efficiency. Transparency. Flexibility. IN A SINGLe investment. Efficiency. Diversification with a single investment. ETFs allow participants to invest in a diversified stock portfolio with a single transaction. As investors in an ETF are allowed to own the stocks that make up the fund s index portfolio, they need not buy the securities of various companies. ETFs combine the simplicity of stock trading with the risk diversification of investment funds. In addition, the ETF management fees are generally lower than the fees charged by the traditional investment funds. Transparency. Access to ETF information in real time. The investors are able to obtain updated information on the evolution of their ETFs from the BM&FBOVESPA website ( and the vendor terminals, in addition to information related to: The trading of ETFs, including information about market prices, trading volumes, trades and financial volumes; The reference value of ETFs (known abroad as IOPV, or Indicative Optimized Portfolio Value) is a tool that allows participants to obtain the theoretical value of ETF portfolios, helping them to make decisions related to investments in ETFs; The value of the indexes underlying the ETFs. Flexibility. Buying and selling an ETF is like buying and selling any stock. ETFs are listed and traded at BM&FBOVESPA and may be bought and sold like any stock. As Exchange-listed securities, ETFs provide investors with benefits that are not available to investors in non-listed investment funds. For example, ETFs may be used by shareholders as collateral for the transactions they carry out at BM&FBOVESPA. In addition, both the ETFs and the stocks that constitute their underlying indexes may be provided as loans in the market, pursuant to the applicable regulations in force.

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6 What parties are involved in ETF transactions? Stock Exchanges: they provide a platform for the listing, trading, settlement and custody of EFTs. Fund portfolio managers: they are responsible for managing the fund s portfolio and for replicating the performance of the reference index. Fund managers: they are responsible for managing the fund and for creating/redeeming ETF units. Authorized agents: the brokerage houses that create and redeem ETF units and maintain a direct relationship with the fund manager. Market makers: the brokerage houses that are continuously present in the market by providing bids and asks for at least a minimum lot of ETFs per bid/ask, subject to a certain maximum spread. They play an important role in providing liquidity to the ETF market. The majority of them also act as authorized agents. Custodians: they ensure the safekeeping of ETFs and ETF component securities, as well as provide for the creation and redemption of ETF units. How can an investor start trading ETFs? Buying or selling an ETF is not any different from buying or selling a stock. Before investing in a particular product, however, one must first become a customer of a brokerage house. Investors must seek the advice of a BM&FBOVESPA brokerage house to receive assistance in selecting the best investment options based on their profile.

7 Buying or selling an ETF is not any different from buying or selling a stock. One must first become a customer of a brokerage house. What is the reference value for an ETF? The reference value for an ETF, also known as IOPV (Indicative Optimized Portfolio Value), is an estimate of the theoretical value of the ETF unit at a given time. The IOPV corresponds to the total value of all the component securities of the ETF portfolio, updated by the most recent Exchange quotations for those securities, and dividing that total value by the number of units. Is the trading price for an ETF equal to its reference value, or IOPV? The trading price for an ETF will vary according to the supply and demand, which, in turn, will reflect the existing market conditions for the stocks that constitute the ETF, the economic conjuncture in Brazil and the general expectations of investors. From this viewpoint, the trading price of ETFs may differ from their reference value or IOPV. However, the market price of an ETF will be very close to its reference value, or IOPV. When the ETF price is higher than the IOPV, the ETF is being traded at a premium, and when the ETF price is lower than the IOPV, the ETF is being traded at a discount. The spread between an ETF s price and its reference value will generate arbitrage opportunities.

8 Creation and redemption of ETF shares The trading of ETFs may either take place on the secondary market when the investor buys and sells an ETF in the Exchange s cash market like any stock or on the primary market when the investor creates or redeems a certain number of ETF shares. Since index funds are constituted as open-ended investment funds, they allow for the creation and redemption of units. Thus, the size of a fund may either increase or decrease through the respective creation or redemption of an ETF. The process of creation takes place when the manager creates an ETF for the authorized agent in exchange for a basket of securities that correspond to the fund s basket of stocks. From the authorized agent s standpoint, the securities are bought at the Exchange and exchanged for ETFs, which are then traded at the Exchange. ETFs can only be created or redeemed by authorized agents in minimum units or in multiples of said minimum units. The authorized agent may also act as a market marker by continuously maintaining bids and asks during the trading session. Similar to the creation process, the redemption process takes place when the authorized agent redeems an ETF in exchange for the Fund s securities. After the ETFs are redeemed, the agent may sell the securities at the Exchange and the manager will cancel those ETFs. Keeping an eye on regulations CVM Instruction 359/2002, which deals with ETFs in Brazil, was formulated based on comparative studies of other countries, such as the United States, Canada, Germany and Hong Kong. Before its final version, this instruction took into account the contributions from various institutions, such as Morgan Stanley, Goldman Sachs, BNDES, BM&FBOVESPA and the American Stock Exchange. What are the risks involved in ETF trading? As with any other investments in the financial market, ETFs are not immune to risks, such as market risk and tracking error.

9 When buying an ETF, the investor takes home a basket of stocks of different companies, thereby reducing the probability and risk of loss. What is market risk? When investing in an ETF, the investor becomes exposed to market risk and to the volatility of the stocks that constitute its underlying index. When market conditions are unfavorable, such as in a recession, when the overall prices of stocks, securities and commodities fall, the value of the ETF will fall in the same proportion. However, investing in such ETF will still provide returns that are close to those of the underlying index. What is tracking error? It is the risk that the ETF manager will fail to exactly replicate the performance of the underlying index. This risk results from the fact that the portfolio of an ETF is not exactly equal to the portfolio of its underlying index. In addition, such factors like management fees and possible time discrepancies in the rebalancing of portfolios may reduce the returns of ETFs in relation to the returns of their underlying indexes.

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11 Do you want to know more? Clarify your doubts with your brokerage house. If you prefer, contact BM&FBOVESPA by telephone at (+55-11) , or access the website www. bmfbovespa.com.br, where you can find all the necessary information to trade ETFs. The intention of this booklet is to provide institutional information about the Brazilian economy and its securities market. It is not a recommendation for investment in any specific financial security. For additional information, please contact a brokerage house to help you evaluate the potential risks and benefits of securities trading, and where you can obtain copies of company prospectuses, rulebooks and other related information. This is a publication of BM&FBOVESPA S.A. - Securities, Commodities and Futures Exchange. The partial or integral reproduction of the content of this publication, by any form or means, without the prior written consent of BM&FBOVESPA, is expressly prohibited, pursuant to the terms of Law No. 9610/1998. Important The content of this publication is provided merely for informational and promotional purposes and should not be regarded as a public offering by BM&FBOVESPA or by securities and commodities brokerage houses. November 2008.

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