ETFs

An Exchange Traded Fund (ETF) is comparable to an investment fund. Investments in an ETF are diversified, similar to those in investment funds. An ETF usually follows an index, such as the AEX or the Dow Jones. That is why it is also called index investing or an index tracker. However, ETFs can also follow a certain ‘basket’ of investments in a particular sector or region. The difference with most investment funds is that an ETF follows the price of an index or basket, whilst most investment funds try to outperform that index or basket. Since most ETFs follow the stock market, they are also known as ‘trackers’ or passive funds.

As the name behind the abbreviation already indicates, ETFs can be continuously traded on the stock exchange. Just like shares. This is an advantage compared to investment funds, which can be traded once a day at one price. So buying and selling ETFs is easy. There is also a disadvantage here. In volatile markets, the bid/ask spread of the ETF may widen. As a result, you may pay a higher price for your buy order or receive a lower price for your sell order.

There are active and passive investment funds and there are active and passive ETFs. The main difference between active and passive is that passive funds (investment funds and ETFs) track an index (benchmark) and active funds try to outperform the index. Passive funds therefore require less management by a fund manager than active funds. This has the advantage for investors that the management costs of passive funds are much lower. Generally, we can say that the costs of passive investment funds such as index funds and passive ETFs that track an index are often lower than the costs of comparable active investment funds and active ETFs.

At ABN AMRO you can trade in a selection of physical and synthetic ETFs:

• A physical ETF that tracks an index or a basket actually buys investments. Physical ETFs buy the underlying investments of the tracked index one-by-one to get the same return as the index (full replication) or they buy a partial selection of the investments to get the same return from the index (partial replication). The risk profile of physical ETFs is similar to the risk profile of the tracked index.
• The synthetic ETF that tracks an index or a basket is artificial: no investments are bought. So there are no physical investments as underlying assets. The synthetic ETF mimics the value development. It works with a ‘swap’: a financial agreement with a large financial party. This party guarantees that the ETF will follow the value development of the index. This party receives remuneration for this. The fund manager processes these costs in the price of the ETF, just like the other costs incurred by the ETF. Synthetic ETFs are usually cheaper than physical ETFs. However, the risk profile of synthetic ETFs is often higher than the risk profile of the tracked index.