ETF Solutions

We understand that investors are seeking portfolios with broader diversification, lower investment minimums, lower expenses and better tax management. That is why we are pleased to provide highly-qualified managers offering tactical and strategic investment strategies.

Exchange traded funds (ETFs) are index funds or trusts that are listed on an exchange and can be traded intra-day. ETFs add the flexibility, ease and liquidity of stock trading to the benefits of traditional index fund investing.

Benefits of ETF Portfolio Management

Broader Diversification

The universe for ETFs is growing rapidly. Managers have the ability to mix ETFs from both domestic and global indices, thus creating an opportunity-rich environment for broader diversified portfolios.

Lower Investment Minimums

Clients can benefit from our ETF portfolios for just $25,000

Lower Expenses

ETFs typically have lower internal expense ratios, helping reduce the cost of portfolio management.

Tax Management

ETFs provide the ability to control the cost basis on the individual holdings, providing a more tax efficient managed portfolio

Transparency

ETFs are designed to generally replicate the holdings and correspond to the performance and yield of their underlying index.

Dividend Opportunities

Dividends paid by companies and interest paid on bonds held in an ETF are distributed to ETF shareholders, less expenses, on a pro-rata basis. Of course, not all companies will pay dividends.

Risk of ETF Portfolio Management

Market risks

An ETF is exposed to the economic, political, currency, legal and other risks of a specific sector or market related to the index it is tracking.

Credit/Counterparty risk

Synthetic ETFs typically invest in over-the-counter derivatives issued by counterparties. Such a synthetic ETF may suffer losses potentially equal to the full value of the derivatives issued by the counterparty upon its default.

Synthetic ETFs are therefore exposed to both the risks of the securities that constitute the index as well as the credit risk of the counterparty that issues the financial derivative instruments for replicating the performance of the index.
Some synthetic ETFs invest in financial derivatives issued by a number of different counterparties in order to diversify the counterparty credit risk concentration. However, the more counterparties an ETF has, the higher the mathematical probability of the ETF being affected by a counterparty default. If any one of the counterparties fails, the ETF may suffer losses.

You should also be aware that the issuers of these derivatives are predominantly international financial institutions and this, in itself, may pose a concentration risk.

For example, if a crisis strikes, affecting the financial sector, it is possible that the failure of one derivative counterparty of an ETF has a “knock-on” effect on other derivative counterparties of the ETF. As a result, an ETF could suffer a loss substantially more than its expected exposure in the event of a single counterparty default.

Some synthetic ETF managers, however, only acquire financial derivatives from one or a few counterparties. These managers may seek to reduce an ETF’s net exposure to each single counterparty by requiring the counterparty(ies) to provide at least 100% collateralization to ensure there is no uncollateralized counterparty risk exposure arising from the use of financial derivatives to replicate index performance
Investors should note in case where collateral is provided by counterparties to a synthetic ETF, the collateral may concentrate on particular market(s), sector(s) and/ or securities issued by specific sovereign or public issuer(s), which may not be related to the underlying index.

Furthermore, when the ETF seeks to exercise its right against the collateral, the market value of the collateral could be substantially less than the amount secured if the market dropped sharply before the collateral is realized, thereby resulting in significant loss to the ETF. Therefore, the relevant synthetic ETF managers have also been required to put in place a prudent haircut policy, in particular, where the collateral taken is in the form of equity securities, the market value of such equity collateral must be equivalent to at least 120% of the related gross counterparty risk exposure.

Tracking error

This refers to the disparity between the performance of the ETF (as measured by its NAV) and the performance of the underlying index. Tracking error may arise due to various factors. These include, failure of the ETF’s tracking strategy, the impact of fees and expenses, foreign exchange differences between the base currency or trading currency of an ETF and the currencies of the underlying investments, or corporate actions such as rights and bonus issues by the issuers of the ETF’s underlying securities

Depending on its particular strategy, an ETF may not hold all the constituent securities of an underlying index in the same weightings as the constituent securities of the index. Therefore, the performance of the securities underlying the ETF as measured by its NAV may outperform or under-perform the index.

Trading at a discount or premium to NAV

Since the trading price of an ETF is typically determined by the supply and demand of the market, the ETF may trade at a price higher (premium) or lower (discount) than its NAV. Also, here the reference index or market that an ETF tracks has restricted access; units in the ETF may not be created or redeemed freely and efficiently.

The supply and demand imbalance can only be addressed by creating and redeeming additional units. So, disruption to the creation or redemption of units may result in the ETF trading at a higher premium or discount to its NAV than may normally be the case for a traditional ETF with no such restriction.

In the event the ETF is terminated, investors who buy at a premium would not be able to recover the premium from the fund.

Liquidity risk

A higher liquidity risk is involved if an ETF uses financial derivative instruments, including structured notes and swaps, which are not actively traded in the secondary market and whose price transparency is not as easily accessible as physical securities. This may result in a larger bid and offer spread. These financial derivative instruments are also susceptible to more price fluctuations and higher volatility. Hence, they can be more difficult and costly to unwind early, especially when the instruments provide access to a restricted market where liquidity is limited in the first place.

Tax and other risks

Like all investments, an ETF may be subject to taxes imposed by the local authorities in the market related to the index that it tracks, emerging market risks and risks in relation to the change of policy of the reference market.

Source:

Investor Education Centre – Understanding Index Tracking ETF

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