[MUSIC] Hi, I'm Frank-Oliver Judt, and I'm working for UBS Wealth Management. I'm responsible for selecting equity and fixed income funds for discretionary minded clients. I'm with my colleague, Thomas Rennemann. Thomas is an equity fund analyst, he's an expert in European active managers and in ETF selection. In this session, we're going to focus on how to best pick an ETF or an Exchange Traded Fund. Buying an ETF is sometimes referred to as, buy the market with one trade. With an ETF, you typically buy a specific market index with all its components. An ETF is a diversified investment vehicle, like a mutual fund. But it has the advantage of being traded during the whole day like a normal stock on the stock exchange. It is usually liquid and quite cheap. The market for ETF has grown strongly in the recent past. In Europe, for instance between 2005 and 2015 the market went ten fold from 50 billion euro to 500 billion euro. In the USA, the market is now estimated at $2 trillion US with 1,800 types of ETF. ETF tracks indices, so they basically have the same performance. The question is how do you choose your ETF, does it actually make sense to pick a particular ETF? So Thomas, you're an expert in the matcher, how do you approach this question? >> Thanks Frank, yes indeed ETF certainly all looks the same at first sight but it's worthwhile taking a sharper look because there are actually some differences. In my practice identified at least three steps that's evaluated when selecting an ETF. First, know what you buy, check the index composition. Second, check the ETF structure, and it's replication methodology. And third, have a comprehensive look at cost and performance. So Thomas, what exactly do you mean by check the index composition. If I want an index, it is by definition efficient and diversified, isn't it? >> I guess you certainly like dividends right? So, let's have a sharper look at the composition of an ETF on the S&P Euro Dividend Aristocrats Index. In this case, you may get larger dividends, however, what you also get is more than 50% in mid-cap stocks. So, companies which are smaller than 10 billion Euro, mid-caps are usually much more volatile than large-caps. So you may not want that into your portfolio. So this is what I meant before with, know what you buy. You must definitely check if the passive strategy you try to replicate also really fits all the investment criteria you need. >> Okay, rule of sophistication number one, know what you buy. Point taken. Let's talk about your second point. The ETF structure and the replication methodology. The ETF replicates one single index so there must be one single methodology isn't it? >> Actually not exactly. There are roughly two families of ETFs, the so called cash based ETFs and the synthetic ETFs. When you buy a cash-based ETF, you become owner of physical securities of the underlying index. This is clearly an advantage, however, physical application means to manage efficiently all index changes. Such index changes can be either or corporate actions, such as dividend payments and stock splits. So we see that the ETF might be a passive strategy, but the portfolio manager has a lot of activity to get the passive right. Furthermore, there are different replication methods that may lead to differences in performance. With full replication, you buy all index constituents. While this optimization or stratified sampling, you buy only a representative part of index. You are applying optimization approach, for instance, when the composition of the index is extremely large and difficult to replicate. Like in the case of global emerging markets, what when the parts of the index cannot be bought, because they are not liquid enough. Know the synthetic structure. When you buy a synthetic ETF, you are not buying physically the underlying. But you're entering into a Swap Contract in order to get economic exposure to the underlying. So this can be an efficient solution, in particular for broad market indices. However, remember, this is a contract. And as a consequence, you're exposed to the risk profile of the company that issued this contract. So you need to analyze the potential counter body risk and the collateral. >> Thanks, Thomas. Let's move to your last point now, the costs. I guess here it is easier. You just take the published total expense ratio or TER or ETF, and you choose the cheapest one, and the job is done, correct? >> Starting with the TER as it would start. However, there’s more to it. The table illustrates that there’s no direct link between the lowest TER ends the best return. On top of the TR, there are usually other effects in TF performance. In some cases, they might be a spot fee. Or the ETF applies performance enhancing activities, such as security landing, activity benefits from certain tax advantages. Such tax advantages accrue when the ETF is domiciled in a location that is efficient for the recovery of taxes on dividends. Furthermore, you need to consider other additional costs of buying an ETF, although its liquidity does not directly impact its performance, you want to check on the trading volumes. In case the ETF has a very low TR, for instance, it may be a new provider trying to get some market share with a fund that is still small, and is fuel on exchange trading. But low trading volumes mean usually a lower number of investors, as well as higher spreads. So my advice here is to consider costs globally in order to get the full picture. >> Thank you Thomas. Let me quickly sum it up. With an ETF, you buy the market with one trade. Despite the fact that ETFs seem to be very similar, you should focus on following three dimensions. First, know what you buy. Check the index composition. Second, check the ETF structure, and it's replication methodology. Third, have a comprehensive look at costs and performance. Thanks for having Thomas and me. [MUSIC]
