Different structures

Different structures

Exchange Traded Funds (ETFs)

ETFs can have different structures, which makes it important that you understand the differences between them before you invest, so that you can find the right fund for your personal investment objectives.

ETFs are UCITS III compliant, open ended collective investment funds that seek to track the performance of a  benchmark index. ETFs are the most common exchange traded product available in Europe and the world today. ETFs can either track their index through holding the underlying securities, so called physical-based, or alternatively by holding a derivative, called SWAP-based.  ETFs offer investors transparent, flexible, liquid and cost-effective access to virtually any asset class.

Physical-based ETFs

A physical-based ETF generally buys all of the securities in the underlying index and holds them as fund assets. In some cases, when it is not considered cost-effective to buy all of the securities in the index (for example when an index is not very liquid), then a process known as ‘optimisation’ is used. This involves buying a portion of the securities within the index and using these to track the index’s performance. For example, in the case of the MSCI World, the iShares ETF holds around 700 securities whereas the index holds more than 1800 constituents.

Physical-based ETFs offer investors best in class  transparency, you know what you own at any time.  In addition, to the benefits mentioned above physical-based ETFs carry no counterparty risk.

Swap-based ETFs

A swap-based ETF uses total return index swaps to replicate an index’s performance.

A swap is an agreement between two parties, in which one party makes payments based on a set rate, either fixed or variable, while the other party makes payments based on the return of an underlying asset, which includes both the income it generates and any capital gains. What this means in essence is that when you buy a swap-based ETF, you are buying the performance of the index, not the physical securities it contains.

Swap-based ETFs can, in some instances, provide a more tax-efficient investment. They can also be a good way of gaining exposure to markets that cannot be accessed through cash-based funds, such as commodities. However, swap-based funds are generally considered a slightly riskier investment when compared to their cash-based equivalent.

Swap-based ETFs remain mutual funds, so do not have issuer-related risk. They are exposed to counter-party risk as they can buy derivatives, lend securities and enter swap agreements for the fund. Counter-party risk is the risk to each party that enters into a contractual agreement, that the other party (or counter-party) will not live up to its contractual obligations

However, in the case of UCITS-compliant swap-based ETFs, the counterparty exposure to the swap cannot exceed 10% of the fund’s net asset value. UCITS is an EU Directive which establishes a common regulatory regime for Undertakings for Collective Investment in Transferable Securities. It is a set of regulatory guidelines for funds that allows compliant fund structures to be marketed throughout the European Union.

Exchange Traded Commodities (ETCs)

ETCs issue debt securities that trade on exchange offering investors direct exposure to commodities.  By investing in ETCs investors gain the desired exposure without the need to trade physical commodities or commodity futures contracts.  An ETC can be either physically backed, or derivative-based. In the first case, physical ETCs will seek to track the daily movement of the spot price of the relevant commodity by holding and valuing the physical commodity.  Most Physical ETCs are to be found in precious metals; gold, silver, platinum and palladium. Precious metals lend themselves to a physical holding structure as they are simple to standardise and relatively inexpensive.  In the second case, a derivative-based ETC typically seeks to track the daily movements of an index based on collateralised commodities futures contracts, for example the S&P Agriculture Total Return Contract.  Derivative-based ETCs can have various degrees of collateralisation: from fully collateralised (limited counterparty risk)  to partially or not collateralised (partial or full counterparty risk).

ETCs are neither funds nor exchange traded funds but instead are typically structured as special purpose vehicles (SPV) which issue debt instruments All iShares Physical ETCs are fully backed by the metal they track.

Exchange Traded Notes ETNs

Similar to ETCs, ETNs are debt instruments that tend to be issued off the balance sheets of the issuing entity rather than an SPV.  ETNs offer exposure to a broad range of asset classes and trading strategies.  ETNs are neither funds nor exchange traded funds and the level of counterparty risk can vary depending on the issuer. Typically ETNs in Europe are underwritten by the creditworthiness of the issuer or guarantor.

As ETNs are notes, ETN investors have direct counterparty exposure to the issuer of the note or to any third party that is guaranteeing the security’s performance. The ETN structure allows for more flexibility in issuing products (i.e. on single commodities and securities).


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