ETFs – Investors' Academy

An exchange-traded fund (ETF) is comparable to an investment fund. Investments in an ETF are diversified, in the same way as investment funds, and therefore have greater diversification than individual shares and bonds. An ETF usually tracks an index such as the BEL20 or the Dow Jones. However, ETFs can also track a defined 'basket' of investments from a certain sector or region. The difference to most investment funds is that an ETF tracks the price of an index or basket as closely as possible, while most investment funds try to outperform that index or basket. Since most ETFs track the performance of the underlying instrument, they are also better known as trackers or passive funds. When the underlying index rises, the ETF increases in value and vice versa.

As the name suggests, ETFs can be traded on the stock exchange at any time, just like shares. This is an advantage compared to investment funds, which can only be traded once a day at a fixed price. Buying and selling ETFs is therefore easy. Yet there is also an obvious disadvantage to this. In volatile (fast-moving) markets, the difference between an ETF's bid and ask prices (the bid-ask spread) may widen. This may result in you paying a higher price for your buy order or receiving 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 funds is that passive funds (investment funds and ETFs) track an index (benchmark), while active funds try to do better than the index. Passive funds therefore require less management by a fund manager than active funds. For investors, this means that the costs of managing passive funds are considerably lower. As a general rule, 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 tracks an index or basket by buying the actual underlying instruments. Physical ETFs buy the underlying investments of the tracked index one-to-one to achieve the same return as the index (full replication), or buy a partial selection of the investments in order to achieve the same return from the index (partial replication). The risk profile of physical ETFs is comparable to the risk profile of the tracked index.
• A synthetic ETF that tracks an index or basket is artificial: no investments at all are purchased. As a result, there are no physical investments as underlying assets. The synthetic ETF replicates the performance of the fund. It works using 'swaps': financial agreements with a major financial party. This party acts as guarantor that the ETF will track the performance of the index. This party receives a payment for doing so. The fund manager builds these costs into the price of the ETF, along with 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.