Investing in ETFs

Investors looking for a safe and transparent way to invest their hard-earned cash are increasingly attracted to exchange-traded funds (ETFs), also known as index funds.

Unlike actively managed funds that charge substantial fees, ETFs are cost-effective, passive funds, meaning they do not require well-heeled fund managers poring over the best strategies to beat benchmark indices.

Instead they simply replicate an index, like the main German share index Dax, one to one. They are considered low-risk and suitable for inexperienced as well as seasoned investors.

"ETFs are wonderful possibility to invest in classical markets like German and American equity markets, even commodity markets, and, in fact, in direct comparison to mutual funds, the costs are less heavy," Robert Halver, head of capital market research at Baader Bank told Deutsche Welle.

There are currently some 890 ETFs to choose from in Germany, which is roughly 100 more than in the United States, the birthplace of index funds. Funds based on the major indices are generally the most popular.

"The classic ETF replicates a blue chip index like the Dax, the Eurostoxx or the Dow Jones and I would always recommend those to investors because they're the classics with the highest liquidity," Marco Cabras from the German Association for the Protection of Investors (DSW) told Deutsche Welle.

ETFs are also a good way to invest in commodities, like gold.

"Without an ETF, I only have the option of buying gold coins, stash them away and hope no one burgles me - or I need a safe," says Cabras.

Germany is Europe's ETF trading hub

Deutsche Boerse, the German stock exchange in Frankfurt, is the main trading hub for ETFs in Europe. Its Xetra trading platform has a market share of 41 percent.

While ETFs have been available in the US since 1993, Deutsche Boerse introduced them to Europe in April 2000 by offering trading in index funds based on pan-European blue chip indices like the Eurostoxx 50. In 2001, the first ETF based on the Dax became available on the exchange.

Since then, the total assets invested in ETFs available in Germany has risen from 400 million euros ($532 million) to a hefty 134.6 billion euros, according to figures from Deutsche Boerse.

It is a trend that is expected to continue.

"If we take a look at the US market, which is more mature and has been around for longer, we see that assets under management of ETFs have a market share of approximately 5 percent, while the same figure for Europe is only 2 percent," Stephan Kraus, vice president of Deutsche Börse's market development team, told Deutsche Welle.

"So, if we use that as a benchmark, I would not be too surprised if, in the next 10 years, the European market were to double in terms of assets under management," he added.

Fund manager fatigue

The popularity of ETFs can in part be explained by investors' disappointment in actively-managed funds, which often struggle to outperform a benchmark index.

According to a recent study by Gecam, an independent financial services provider that analyzed thousands of funds all over Europe, three in four managed funds mirrored indices by up to 90 percent over the last three years. Critics say that means the main difference between some active funds and ETFs is the fee structure.

ETFs often perform just as well as managed funds and charge much lower fees, typically around 0.2-0.4 percent compared with 5 or 6 percent for classic funds.

Increasingly complex funds

Around 90 percent of ETFs traded on the German stock exchange are those replicating an index one to one by buying a basket of the underlying shares in that index.

But with the segment experiencing a boom, providers are now offering more sophisticated - or, some would say, riskier - products.

"There are ETFs out there now who do not buy the underlying securities of the index but use complicated mathematical constructs like financial swaps. That means the shares in the Dax aren't actually being bought for the ETF - the money is invested elsewhere through those swaps. That's not good for private investors," Cabras from DSW advises.

Others point out that those tools are well-established in the financial markets and backed by ample liquidity.

"We've seen definitely that monetary policy worldwide is pumping billions and billions of euros and dollars into the markets and thereby saving the whole financial markets," Halver says.

"We cannot allow a new financial crisis and that's why I would say I have no fear of ETF structures based on swaps.

Deutsche Boerse advises investors to be aware of the strategies available, but Kraus points out that the main growth in the ETF markets will continue to come from classic ETFs.

"Investors will use those major, established plain vanilla ETFs in order to get exposure to markets in a cost-effective way," he told Deutsche Welle.

Author: Nicole Goebel
Editor: Sam Edmonds