ETFs and Index Funds. Similarities and Differences. For professional clients only

Transcription

1 ETFs and Index Funds Similarities and Differences For professional clients only

2 Most Exchange Traded Funds (ETFs) and index tracker funds share a common aim. That is, to match the performance of the index that they are tracking. However, some of the features of each investment vehicle are quite different. HSBC Global Asset Management offers a suite of 28 ETFs and 8 index tracker funds that aim to provide tailored market access to our clients. In this document we aim to set out some of the similarities and differences between ETFs and index tracker funds. We hope this will help our clients to make informed decisions as to which product is best for their specific investment needs.

3 Similarities 1 2 Both offer diversified access to markets around the world When investing in either an ETF or an index tracker fund, clients are gaining exposure to the securities within the index being tracked. From the outset, therefore, an ETF or index tracker fund investment is by definition more diversified than buying a share in a single company. The fact that there is a wide range of ETFs and index tracker funds available on the market, offering exposure to many different countries/regions and sectors around the world, allows clients to further diversify their portfolios. An investment in either product can therefore provide customised levels of market access, from broad global exposure to regional markets, single country indices or specific index sub-sectors. These twin aspects of diversification (at the first level, the fact that an investment is index-wide and at the second level, the fact that an investment can be made across a variety of indices worldwide) mean that both ETFs and index tracker funds represent a cost-effective way of helping clients construct a highly diversified portfolio, spreading risk across different regions and sectors. Both offer lower costs when compared to active funds ETFs and index tracker funds offer lower costs when compared to actively managed funds. This partly reflects the fact that they are both aiming to replicate the performance of the benchmark, and are not seeking to outperform it. As a result, passive fund managers will rebalance their portfolios in line with benchmark rebalances and will therefore incur less trading costs when compared to an active strategy. 3 Both seek to track indices in an efficient manner There are a number of ways for an ETF or index tracker fund to track an index. The first (and most common) method is known as full physical replication, where the fund owns all of the securities in the underlying index, in the same proportion as the index. For an individual investor, buying shares in a fully-replicated physical fund is a more cost-effective way of gaining access to an entire market rather than buying all of the individual stocks listed in that index. A second option is known as optimisation. This is where the fund owns a proportion of shares in the underlying index. We believe that optimisation is the preferred investment solution when it is not cost-effective to buy all of the securities in the index (i.e. for very broad indices with a large number of constituents or indices with less liquid constituents) or for investors seeking exposure to harder-to-access markets, such as emerging markets. The third option is known as synthetic (or swap-based) replication. These funds use swaps and other derivative products to obtain market access. At HSBC, we use either full replication or optimisation across our range of ETFs and index tracker funds. We believe that the risks associated with synthetic funds the most important of which is counterparty risk make them a less attractive investment option. Moreover, as outperformance is not an investment objective, neither ETFs nor index tracker funds need active managers or stock-pickers to generate outperformance. Rather, a quantitative-based investment approach helps to keep management fees down. However, although both ETFs and index tracker funds tend to have lower costs than active funds, their cost structures are quite different from one another, which we explain in detail in the Differences section below. Comparing ETFs and Index Funds 3

4 Differences 1 How they are traded/priced The most important difference between an ETF and an index tracker fund is that an ETF is traded like a share. This means that an ETF can be bought and sold at any time during the trading day via a stock exchange or other trading platform. ETF are therefore subject to a bid/ask spread (the difference between the prices quoted for an immediate purchase or sale) on exchange. This also means that the price of an ETF is constantly changing during the trading day according to market conditions. However, an index tracker fund (such as an OEIC) is usually priced once per day. The buying and selling of an index tracker fund investment can be carried out either directly with the fund provider or via a fund platform. To protect long-term shareholders from the transaction costs (such as bid-offer spreads, brokerage commissions and taxes) incurred by a fund as a result of new daily subscriptions or redemptions, HSBC operates a pricing adjustment (also known as swing pricing ) across its range of index tracker funds. Swing pricing occurs when the difference between subscriptions and redemptions, as a percentage of the total net asset value (NAV) of the fund, exceeds a pre-determined threshold on any particular valuation day. This threshold (which is disclosed) is reviewed on a quarterly basis and can also be adjusted when necessary to respond to market-specific circumstances. Utilising swing pricing means that only those investors buying and selling fund shares on any given day pay transaction costs, with these costs not passed on to all long-term shareholders in the fund. 3 The first difference to consider is that ETFs have no minimum investment requirement, with purchases starting from one share. Index tracker funds do set minimum investment requirements, which vary from provider to provider. When it comes to buying and selling an index tracker fund, fund providers can (but do not always) charge entry/exit fees when trading directly with the client. These entry/exit fees can also sometimes be waived when buying and selling via a fund platform. ETFs do not carry entry/exit fees. However, as they are traded on exchange, buying and selling ETFs entails brokerage fees, with ETF pricing also subject to bid/ ask spreads on exchange. Clients also need a trading account with a broker (or other share dealing platform) in order to trade their ETF investment. Ongoing costs There are standard annual charges for both types of fund: The main annual fee for an ETF is the Ongoing Charges Figure (OCF). This incorporates elements such as the management fee and a list of other costs carried by the asset manager; these include administration, custody and audit fees, legal, regulatory and registration expenses. The main annual fee for an index tracker fund is the OCF. The OCF is made up of the Annual Management Charge (AMC) and other operating costs. Other operating costs include the costs for other services paid for by the fund, such as the fees paid to the trustee (or depository), custodian, auditor and regulator. 2 ETF also have an equivalent feature to protect existing investors. ETF shares can be created/redeemed at any time via a process known as creation/redemption in the Primary Market (where shares are created and redeemed in return for baskets of securities or cash without a meaningful impact on the underlying market), through an authorised participant who will pay a fee equivalent to the transaction cost incurred. This cost will generally be passed on to the incoming/leaving investor. What charges/fees they carry As well as differing in their pricing and trading characteristics, ETFs and index tracker funds have different cost structures. Additional costs to consider Beyond the standard annual charges, investors in equity ETFs and index tracker funds also need to consider the impact of both corporate actions (such as mergers and acquisitions, stock splits, rights issues, spin-offs or the receipt of interest/dividends) and index rebalancing (usually once per quarter). Such changes will need to be reflected by the fund, which may then generate trading costs or other implicit costs to do with corporate activity in the underlying investment. 4 Comparing ETFs and Index Funds

5 4 How often their holdings are disclosed Both ETFs and index tracker funds offer greater levels of transparency when compared to active funds. As a result, it is easier for clients to know what they own. When considering major world indices (such as the FTSE 100), media coverage of how the index is performing is readily accessible. If the index is performing well, then an ETF or index tracker fund tracking that index should also be performing well. However, when it comes to disclosing exactly what they own, ETFs offer greater levels of transparency than index tracker funds. Most ETF providers publish a full list of the securities that they hold on a daily basis. Most index tracker fund providers publish a full list of the securities they hold on a monthly, quarterly or annual basis, although Top 10 holdings are usually disclosed monthly. 5 How broad their range is ETFs and index tracker funds provide global investment access - across both developed and emerging markets. Over recent years, there has been rapid growth in the range of ETFs available, notably in harder-to-reach areas (such as equity index sub-sectors, or Emerging Markets). This is partly due to the fact that many ETFs are crossborder investment vehicles (i.e. they are able to be bought and sold on different exchanges). Therefore, they have the potential to attract greater fund inflows from a broader range of investors than index tracker funds such as OEICs, which are registered within a single country. This greater potential pool of investment can make ETFs a more viable investment vehicle when launching a new fund into harder-to-access market areas, such as Emerging Markets. So, which type of fund should I choose? There is no right or wrong answer to this question. ETFs and index tracker funds both have their strengths and weaknesses and much depends on the circumstances of the individual investor. With that in mind, the following observations can be made: Both ETFs and index tracker funds can be suitable for investors with a long-term investment horizon This reflects the fact that index tracking represents an investment approach that broadly expects equity markets to gain in value over the long term. ETFs can also be used by investors with a shortterm investment horizon As ETFs are traded on exchange like shares, and there are no entry/exit fees charged on most funds. It makes ETFs compared to index tracker funds more suitable to be used for taking short-term positions within global markets in a cost-effective manner. Both ETFs and index tracker funds can bring diversification to a client portfolio Although ETFs can go slightly further in their market coverage When considering the range of funds available, there are currently a greater number of ETFs offering exposure to harder-to-reach market areas (such as Emerging Markets) than index tracker funds. Both ETFs and index tracker funds offer low costs when compared to active funds This reflects the fact that both types of fund are seeking to match index performance, and not incurring the extra trading and other costs involved with an active investment style. But their cost structures are quite different Both funds charge an annual fee, the OCF*. However, there are other costs to consider for both types of investment, including trading costs, corporate actions and the treatment of dividends. This reflects the fact that, with both types of investment, clients are effectively gaining access to an index through a single investment. *As at July Ongoing Charge Figure (OCF): Charges taken from the fund over a year. This figure excludes transaction costs Comparing ETFs and Index Funds 5

6 Key Features Compared ETFs Index Tracker Funds How they are bought and sold On exchange via broker or Over The Counter (OTC) Via fund provider or fund platform Buying costs Brokerage/advice charges Platform fees/advice charges How they are traded Intraday on exchange Once a day How they are priced How they are dealt Continuously during market hours, reflecting underlying value. At net asset value (NAV) after market close Price is subject to bid/offer spread on exchange Traded at market price during trading day, at NAV after close Once per day with price at valuation point Price also subject to swing pricing to protect long-term shareholders from daily transaction costs related to subscriptions/redemptions Ongoing charges Ongoing Charges Figure Ongoing Charges Figure Minimum investment One share Set by provider/platform Entry/Exit Fees No Sometimes In and Out Flow management Liquidity Fund creates/redeems new shares in lots of basket size on the primary market Multiple authorised participant model ensures continuous liquidity on exchange. Further liquidity provided by primary market creation/ redemption process Fund manager trades based on cash flows into fund Shares issued and redeemed by provider Conclusion In this document, we have set out some of the key similarities and differences between ETFs and index tracker funds. Overall, we believe that both types of fund can offer cost-effective and diversified access to markets around the world. Each investor has different needs and requirements and these would be the main drivers behind their own choice of investment vehicle. Index tracker funds and ETFs are both widely available to gain cost-effective exposure across developed world markets and harder-to-reach markets, such as Emerging Markets. 6 Comparing ETFs and Index Funds

7 Why choose HSBC? HSBC s range of ETFs and index tracker funds has been designed with the client in mind. To that end, HSBC has used its global presence to create a range of ETFs and index tracker funds across both developed and emerging markets that provide exposures to the areas where our clients are looking to invest. Global reach HSBC s range of ETFs and index tracker funds is managed by HSBC Global Asset Management, a leading global investment manager with a long track record of providing sound investment solutions to a wide range of investors around the world. We have been managing passive investments for over 25 years. HSBC s range of index tracker funds is focused on developed world markets. The fund range encompasses seven equity funds (three UK and one each for Europe, Japan, Pacific and US) and one UK bond fund. HSBC s range of ETFs offers Global, Regional, Developed and Emerging Market equity exposure. HSBC s large footprint in Emerging Markets has allowed us to develop a successful broad Emerging Market ETF offering to sit alongside our Developed Market products. This combined offering allows investors to access global equity markets and manage global investment portfolios. HSBC has a long track record in emerging market investment and we can subsequently offer direct market access on many local stock exchanges. We are therefore able to go further in offering ETFs based on this fast-growing market sector than other providers. We were the first in Europe to offer investors a physically replicated Russian ETF investing in local Russian stocks. Strong performance track record HSBC has a strong record on tracking error across our range of ETFs and index tracker funds when compared to our peers. HSBC s robust quantitative portfolio management and trading processes ensure that HSBC funds are able to track their benchmark indices closely. Moreover, our overall investment approach remains conservative. We believe in strong levels of risk management and governance for our range of ETFs and index tracker funds, aiming to deliver minimum tracking error at a competitive price to our clients. All HSBC ETFs are UCITS IV compliant, and both ETFs and Index tracker funds are ISA and SIPP eligible and have UK Reporting Fund status. Comparison of key features of HSBC s range of ETFs and Index Tracker Funds ETF range Index Tracker Fund range* Minimum investment One share GBP1mn direct. Lower minimum investments will apply to business done via platforms Ongoing charges Variable competitive OCF ( %) Variable OCCF (0.17% and 0.23%) Investment vehicle Dublin UCITS IV compliant funds registered for distribution across Europe OEIC Cross-listings UK, France, Switzerland, Germany Not applicable Launch date Fund range 28 funds 9 funds * C share class accumulation units. OCF data as at Comparing ETFs and Index Funds 7

8 Contact For more information, please contact us: Telephone: +44 (0) Website: Key Risks Market risk: Geographic risk: 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. Currency risk: Where overseas investments are held, the rate of currency exchange may cause the value of such investments to go down as well as up. Emerging market risk: Investments in emerging markets are by their nature higher risk and potentially more volatile than those inherent in some established markets. Some of the ETFs invest predominantly in one geographic area; therefore any decline in the economy of this area may affect the prices and value of the underlying assets. Russian risk: There are significant risks inherent in investing in Russia, which could affect the value of investment. These include a lack of clarity in laws and regulations in the following areas: investor protection, banks and other financial services, the Russian economic system, taxation, transaction settlement and fiduciary duty and responsibilities of company management. Performance risk: Past performance is not an indication of future returns. Important Information This document is intended for professional clients only and should not be distributed to or relied upon by retail clients. The material contained herein is for information purposes only and does not constitute investment advice or a recommendation to any reader of this material to buy or sell investments. Care has been taken to ensure the accuracy of this document, but HSBC Global Asset Management (UK) Limited accepts no responsibility for any errors or omissions contained therein. Any views expressed were held at the time of preparation and are subject to change without notice. HSBC ETFs are sub-funds of HSBC ETFs plc, an investment company with variable capital and segregated liability between sub-funds, incorporated in Ireland as a public limited company, and authorised by the Central Bank of Ireland. The company is constituted as an umbrella fund, with segregated liability between sub-funds. Shares purchased on the secondary market cannot usually be sold directly back to the Company. Investors must buy and sell shares on the secondary market with the assistance of an intermediary (e.g. a stockbroker) and may incur fees for doing so. In addition, investors may pay more than the current Net Asset Value per share when buying shares and may receive less than the current Net Asset Value per Share when selling them. UK-based investors in HSBC ETFs plc are advised that they may not be afforded some of the protections conveyed by the Financial Services and Markets Act (2000), ( the Act ). The company is recognised in the United Kingdom by the Financial Conduct Authority under section 264 of the Act. All applications are made on the basis of the current HSBC ETFs plc Prospectus, relevant Key Investor Information Document ( KIID ), Supplementary Information Document (SID) and Fund supplement, and most recent annual and semi-annual reports, which can be obtained upon request free of charge from HSBC Global Asset Management (UK) Limited, 8 Canada Square, Canary Wharf, London, E14 5HQ. UK, or from a stockbroker or financial adviser. Investors and potential investors should read and note the risk warnings in the prospectus, relevant KIID, SID and Fund supplement. The shares in HSBC ETFs plc have not been and will not be offered for sale or sold in the United States of America, its territories or possessions and all areas subject to its jurisdiction, or to United States persons. Affiliated companies of HSBC Global Asset Management (UK) Limited may make markets in HSBC ETFs plc. The HSBC index tracking funds referred to overleaf are sub-funds of HSBC Index Tracker Investment Funds, an Open Ended Investment Company that is authorised in the UK by the Financial Conduct Authority. The Authorised Corporate Director and Investment Manager is HSBC Global Asset Management (UK) Limited. All applications are made on the basis of the HSBC Index Tracker Investment Funds prospectus, Key Investor Information Document (KIID), Supplementary Information Document (SID) and most recent annual and semi annual report, which can be obtained upon request free of charge from HSBC Global Asset Management (UK) Limited, 8, Canada Square, Canary Wharf, London, E14 5HQ, UK, or the local distributors. The information in this document is based on HSBC s interpretation of current legislation and HM Revenue & Customs practice. While we believe that this interpretation is correct, we cannot guarantee it. Legislation and tax practice may change in the future. Tax treatment is based upon individual client circumstances. HSBC Global Asset Management (UK) Limited provides information to institutions, professional advisers and their clients on the investment products and services of the HSBC Group. This document is approved for issue in the UK by HSBC Global Asset Management (UK) Limited who are authorised and regulated by the Financial Conduct Authority. Copyright HSBC Global Asset Management (UK) Limited All rights reserved /AS/0914/FP Expiry date 04/03/2015