ETF: the main elements you need to know before investing – 26.07.2022 at 12:10

(Photo: Adobe Photos Stock - Fokussiert)

(Photo: Adobe Photos Stock – Fokussiert)

ETFs: Important elements to know before investing

ETFs (or trackers) are becoming increasingly popular among French investors, they are investment funds that trade on the stock exchange like shares and that allow you to easily diversify your portfolio.

However, with several thousand ETFs listed on European exchanges, choosing which ETF to invest in can quickly become a real headache.

In this article, we will see the main elements to check and know before investing in ETFs.

The underlying asset in which the ETF is invested

ETFs can replicate (physically or synthetically) a variety of underlying assets, such as major stock indexes, as well as thematic stock portfolios, commodity baskets, bond portfolios, and even cryptocurrencies.

It can also be an ETF that provides hybrid exposure (stocks + bonds).

It is all the more important to check the composition of the ETF before investing, as it happens that a “renewable energy” ETF invests not only in companies in the renewable energy sector, but also in other related sectors.

ETF issuer

There are many ETF issuers. Among the most famous are BlackRock, Amundi, Vanguard, Invesco, Xtrackers, State Street and even Franklin Templeton.

There are also new issuers such as HANetf, RizeETF, Mellanion Capital, 21Shares.

Although all ETF issuers are subject to the same rules and obligations, it is important to ensure that the ETF issuer is sound and not at risk of bankruptcy.

Daily volumes

Many investors mistakenly place value on the amount of assets under management (AUM) in an ETF. It’s true that an ETF with hundreds of billions of dollars in assets under management can inspire confidence.

However, the AUM size of an ETF is not an important criterion because ETFs are open-end funds. Assuming an investor wants to invest €10 million in an ETF that only has €10,000 of assets under management… the issuer can create as many new securities as needed to satisfy the investor’s demand. The only real limitation is the available liquidity of the underlying asset. If the underlying is the S&P500, the true liquidity constraint is equivalent to the liquidity of the S&P500.

However, it may be appropriate to check daily volumes. Low volumes can mean higher bid-ask spreads in the market.

ETF expenses

ETF management fees (TFE or TER) range from 0.10% to 0.90% per year. The fee is included in the ETF valuation.

Index ETFs that track the performance of the S&P 500, Nasdaq 100, DAX, CAC 40 or other major stock indexes are generally the cheapest in terms of fees (0.10% to 0.25%).

ETF management fees are indexed to product complexity. Therefore, a thematic ETF or SRI/ESG ETF will have higher management fees than an index ETF due to the analytical work the manager does to select the stocks that make up the fund. Conversely, an index ETF requires less work for the manager because it will simply replicate the composition of a stock market index.

ETFs with the highest fees (>1%) are complex ETFs that require daily management or incur operational costs for the issuer. These include “actively managed” ETFs and “leveraged and short” ETFs.

More insightful than focusing strictly on the size of the ETF management fee, it is necessary to compare the amount of the fee with the results provided.

ETF performance

Before you start talking about ETF performance, remember that past performance is not indicative of future performance.

In this chapter, we will exclude leveraged ETFs and inverse ETFs because they are complex products whose performance is calculated daily, including beta slippage.

We will also exclude “actively managed” ETFs, as well as thematic ETFs whose performance is largely dependent on the performance of the manager.

So let’s focus on index ETFs, whose performance may differ from the index it tracks. Then we talk about “tracking errors” when the ETF’s return deviates from the index’s return.

It is better to choose an index ETF with low or no tracking error.

Some sites report a difference in performance.

Dividend distribution policy

When it comes to looking at dividends with ETFs, there are two types of ETFs:

Distribution of ETFs

This type of ETF distributes and pays investors dividends earned by the fund. Payments can be made monthly, quarterly or annually. This type of ETF is ideal for investors who want regular income.

ETF capitalization

This type of ETF reinvests dividends received to purchase additional shares. For long-term investors, this type of ETF will allow you to benefit from a compounding effect that can increase returns tenfold.

Eligibility for PEA ETFs

The same eligibility criteria that apply to UCITS will determine whether an ETF is eligible for a PEA.

Reminder: at least 75% of the fund must be invested in PEA-eligible shares, i.e. shares of companies whose head office is located in a member state of the European Union.

There is an ETF feature that allows ETFs to be eligible for PEA when they are invested in foreign markets (US, Asia, etc.). This is thanks to a hybrid replication mode that physically copies European stocks and synthetically copies foreign stocks. Thus, the ETF remains primarily invested in Europe, while providing access to other markets.

In conclusion, even though ETFs are financial products that simplify and democratize investing in the stock market, you should not rush to buy ETFs and you should do some due diligence beforehand. If in doubt, most ETF issuers have a team of advisors who can answer your questions… So don’t hesitate to contact them!