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Deutsche Bank
Portfolio & Index Strategy
How to use ETFs
Nizam Hamid
44 20 7545 2955
[email protected]
Gaining Global Asset Exposure
Exchange Traded Funds represent the easiest way for investors to gain exposure to a
wide range of asset classes. ETFs are best thought of as index-based funds that trade
and settle on an exchange like ordinary shares with the benefits of continuous pricing,
high levels of underlying liquidity and easily accessible net asset value information.
Yvonne Sandford
44 20 7545 1368
[email protected]
This means that investors can chose between equity, fixed income, commodity and
currency exposure with a considerable degree of depth in terms of available products.
The equity ETF market in Europe offers products that range from country and sector
indices, to broad regional benchmarks, style indices, commodities, fixed income
and also managed products that offer leveraged returns on various indices.
The most important aspect of ETFs from an investors’ perspective is that they are
extremely simple to trade and settle compared to other similar products such as
futures or index swaps. ETFs trade, price and settle just like ordinary shares whilst
being open ended collective investment schemes. The vast majority of European
listed ETFs are also UCITS III compliant helping to broaden their appeal.
The growth in ETFs, both with respect to new product issuance and increase in
assets under management, is bring driven by investors looking to gain broad exposure to asset classes that can be difficult to trade efficiently by using futures or more
narrow-based ETFs. Investors looking to track a MSCI World benchmark can use
futures baskets, however, there are significant roll-related risks and costs to consider whilst tracking errors are around 150bps. In comparison a swap-based MSCI
World ETF has a tracking error of 3bps. Similarly for Emerging market exposure, a
futures basket would have a tracking error of 541bps whilst a swap-based ETF on
the same index as a tracking error of 4bps.
We expect that investors will increasingly prefer swap-based ETF exposure due to
the combination of certainty over both costs and tracking error, especially relative to
complex broad benchmarks.
Figure 1: Historic European ETF AUM (Em)
Figure 2: Historic US ETF AUM (US$m)
8 0 ,0 0 0
6 0 0 ,0 0 0
7 0 ,0 0 0
5 0 0 ,0 0 0
6 0 ,0 0 0
4 0 0 ,0 0 0
5 0 ,0 0 0
AUM (US$m)
ETF AUM (Em)
Global Markets Research
25 February 2008
4 0 ,0 0 0
3 0 ,0 0 0
3 0 0 ,0 0 0
2 0 0 ,0 0 0
2 0 ,0 0 0
1 0 0 ,0 0 0
1 0 ,0 0 0
0
M a y -0 3
F e b-0 4
No v -0 4
A u g -0 5
M a y -0 6
F e b -0 7
No v -0 7
Source: Deutsche Bank, Bloomberg, Reuters
0
A p r-0 3
J a n-0 4
O c t- 0 4
J u l- 0 5
A p r-0 6
F e b-0 7
N o v -0 7
Source: Deutsche Bank, Bloomberg, Reuters
IMPORTANT: PLEASE READ DISCLAIMERS AT THE END OF THIS REPORT
Deutsche Bank AG or one of its affiliates may make a market in one or more of the ETFs mentioned in this document.
This document has been prepared for institutional investors only.
This note is not intended to promote or offer any ETF in any jurisdiction in which an offer, solicitation, purchase or sale of such
fund would be unlawful under the securities laws of such jurisdiction.
Deutsche Bank AG/London
All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced
from local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject
companies.
Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should
be aware that the firm may have a conflict of interest that could affect the objectivity of this report.
Investors should consider this report as only a single factor in making their investment decision.
Independent, third-party research (IR) on certain companies covered by DBSI's research is available to customers of
DBSI in the United States at no cost. Customers can access this IR at http://gm.db.com, or call 1-877-208-6300 to
request that a copy of the IR be sent to them.
DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1.
Deutsche Bank
How to use ETFs
25 February 2008
The Benefits of ETFs
Exchange Traded Funds (ETFs) provide investors with low cost exposure to a wide range
of equity and fixed income benchmarks through the ease and flexibility of trading a single
stock. ETFs benefit from being simple to trade with a combination of significant liquidity
in both the ETFs and typically the underlying basket of components.
The success and widespread use of ETFs can be best seen from the US example where
they represent close to 50% of total cash equity trading turnover as investors can use
them to execute a number of portfolio management and trading strategies. Recent trading
volumes in the US ETF market have averaged over $90bn per day. In Europe, the still
evolving ETF market, currently has on exchange turnover of around E1.7bn per day and an
estimated total of around E2.5bn per day including off exchange transactions.
Simple Products to Trade
-
ETFs are both simple to trade and low cost, representing an index product in a single
share
-
As a single stock ETFs are easier to settle and provide continuous pricing
-
An equity product that fits more naturally into a stock portfolio than either futures or
options
-
Products available from all the main index providers covering a wide range of domestic
and international asset types and classes
One of the main attractions of ETFs is that they are easy products to trade and settle as
they are treated in the same way as shares. This means that investors can trade whole
equity regions, asset classes and index based products as easily as trading single stocks.
The ease of trading and settlement makes ETFs more attractive for many asset managers
than futures, options and swaps, which are typically more complex to manage on an
ongoing basis.
Figure 4: Historic US ETF Turnover (US$m)
Figure 3: Historic European ETF turnover (Em)
2 ,0 0 0
1 2 0 ,0 0 0
1 ,8 0 0
1 ,6 0 0
1 0 0 ,0 0 0
1 ,2 0 0
Turnover (US$m)
ETF Volume (Em)
1 ,4 0 0
1 ,0 0 0
800
600
400
200
8 0 ,0 0 0
6 0 ,0 0 0
4 0 ,0 0 0
2 0 ,0 0 0
0
M a y -0 3
F e b -0 4
N o v -0 4
S e p-0 5
J u n -0 6
M a r-0 7
J a n -0 8
0
A p r -0 3
J a n-0 4
O c t-0 4
A ug-0 5
M a y -0 6
M a r-0 7
D e c -0 7
Source: Deutsche Bank, Reuters
Source: Deutsche Bank, Reuters
Figure 5: European Turnover by ETF Index Type (Em)
Figure 6: US Turnover by ETF Index Type (Top 10) $m
L arge C a p
Euro pe an C o untry
US S ec t
Euro zo ne R egiona l
Euro pea n Le ve ra ged
S m all C a p
W orld C o untry
S tyle - S ho rt
Pan-Europe a n R egiona l
Pa n-Euro pea n Se c tor
G lob al Re g
Style
E m e rging C try
G loba l
S tyle - M ana ge d
G loba l R egiona l
Sec to r C o untry
D e velo pe d C try
O ther
M id C a p
Euro Se c tor
0
10 0
20 0
30 0
40 0
50 0
60 0
70 0
0
80 0
10 ,00 0
Source: Deutsche Bank, Reuters
Source: Deutsche Bank, Reuters
2
Global
2 0,0 00
30 ,00 0
V olum e (US $ m )
Vo lume (Em)
Portfolio & Index Strategy
40 ,000
5 0,00 0
60 ,00 0
25 February 2008
How to use ETFs
Deutsche Bank
Fundamental to the efficiency of the ETF market and the pricing of ETFs is the underlying
net asset value of the fund. This is tied to the index that the fund is tracking. So that price
discovery can take place in an orderly fashion it is normal for exchanges, on their ETF
platforms, to calculate and publish live indicative net asset values based on information
provided to the exchanges by the ETF issuers. The need to have high levels of transparency
and disclosure ensures that investors have confidence in the data underlying the pricing
environment.
Pricing and liquidity is further enhanced by the presence and participation of dedicated
market makers and liquidity providers. Investors can trade ETFs, as with shares, based on
the liquidity available within the order book on the various exchanges. In markets where
there are particularly liquid ETFs this liquidity may be sufficient for normal trading volumes.
The recent dramatic growth in both turnover and assets under management has been
fueled by the sharp reduction in ETF fees, especially for some of the most popular products,
notably the EURO STOXX 50 and the DAX, combined with a rapid expansion of the types
of ETFs available. Overall the downward shift in fee structure has made ETFs significantly
more attractive to institutional investors.
Primary traders / market makers have access to the creation and redemption process that
is critical to the efficient trading process for ETFs if investors wish to trade in significant
volumes. Ultimately it is important for investors to recognise that the liquidity of an ETF is
a function of both the trading volume of existing units of the ETF and the average daily
volume in the basket of stocks that represent the underlying constituents of the ETF.
Trends in assets under management for ETFs give a clear indication of their use to gain
exposure to non-local markets. In Europe three of the top ten ETFs are for non-European
equities, whilst in the US the second and third largest ETFs in terms of assets are based
on non-US equities and represent over $70bn of AUM. In terms of listings, the largest
number of ETFs in Europe are those based on non-European countries with over 49 ETFs,
including cross listings this is the largest group in Europe at 180 ETFs. There are also 16
Global regional ETFs that have broad equity coverage. The US market, whilst dominated
by the recent issuance of style-based ETFs also features a wide range of liquid non-US
country and regional ETFs.
Figure 7: Europe - No of ETFs (inc cross listing)
200
180
180
20 0
186
18 0
160
143
140
16 0
120
120
14 0
102
12 0
100
80
70
60
42
48
71
76
14
96
10 0
80
49
60
40
20
Figure 8: US No of ETFs
15
52
36
40
World Country
Style
Pan-European
Sector
Other
Global
Regional
European
Country
Eurozone
Regional
Style - Other
US Sect
Global
22
Other - Managed
Pan-European
Regional
18
Global Sect
European
Leveraged
14
Global Reg
Sector Country
14
Developed Ctry
Euro Sector
13
Small Cap G/V
12
Mid Cap G/V
9
Large Cap G/V
7
Large Cap
7
Emerging Ctry
6
NorthAm Ctry
6
Europe Reg
Asia Reg
6
Small Cap
3
Broad G/V
1
Americas Reg
0
Mid Cap
20
0
Source: Deutsche Bank
Source: Deutsche Bank
Figure 9: European AUM per index type (Em)
Figure 10: US AUM (top 10)
Eurozone Regional
S&P 500
European Country
MSCI EAFE
World Country
MSCI Emerging Market
Pan-European Sector
Pan-European Regional
Nasdaq 100
Global
Russell 1000 Growth Index
Style
S&P 400
Other
Russell 2000
Global Regional
MSCI US Broad Market Index
European Leveraged
DJIA
Euro Sector
Russell 1000 Value Index
Sector Country
0
5,000
10,000
15,000
0
20,000
Source: Deutsche Bank, Bloomberg
20
40
60
80
100
120
AUM (US$ bn)
Assets under Management (Em)
Source: Deutsche Bank, Bloomberg
Global
Portfolio & Index Strategy
3
Deutsche Bank
How to use ETFs
25 February 2008
The Creation / Redemption Process
Investors should focus on the creation and redemption process as being fundamental to
the use of ETFs, especially in case of products where the ETF does not have significant on
exchange liquidity. Typically it is best for investors to deal through a broker that already
has high cash equity flows. The ability to create ETFs by accessing natural flow can help
lower costs by minimising market impact and trading costs.
New units of an ETF can be created at the ETF’s NAV either through the delivery of a
basket of securities or cash. Investors need to go through an authorised participant in
order to implement any creations or redemptions. Typically there will be minimum size
requirements and a fee may be charged. ETF providers and asset managers publish the
net asset value for cash subscription together with the composition of the perfect basket
on a daily basis. This allows authorised participants to buy the securities that underlie the
ETF and deliver these to the ETF asset manager that then delivers the ETF shares to the
purchaser. In this way, investors then hold and trade the ETFs just like shares.
Increasing the use of ETFs
There are several factors that are likely to prompt the growth of the use of ETFs in the
European market place. The first change relates to the regulatory environment and the
adoption of UCITS III (Undertakings of Collective Investment in Transferable Securities).
This opens the way for funds to be able to invest in other UCITS and non-UCITS products
as long as they are deemed to be UCITS compliant. UCITS compliance has been relaxed
so that in terms of indices as long as they are sufficiently diversified and adequately
represent the underlying market they can be considered compliant. Index funds are a
clear beneficiary from this change and given that ETFs are typically based on established
benchmarks this should make the products more attractive for a number of investors.
Additionally investors can have a higher overall exposure to single products thus opening
up the opportunity to use ETFs for a wider range of portfolio strategies.
Creation / Redemption Process - Swap-based ETF
Secondary Market
Primary Market
Block trades
Designated
Sponsor
ETF fund
manager
Senior
Market
Maker
Designated
Sponsor
liquidity
Designated
Sponsor
Institutional
and
alternative
investors
ETF Segment
of equity
market
Designated
Sponsor
Publication of NAV
Source: Deutsche Bank
4
Global
Portfolio & Index Strategy
Buying and selling of ETFs with
cash
Private
investors
25 February 2008
How to use ETFs
Deutsche Bank
Factors impacting ETF structure and performance
The traditional ETF structure based on the fund owning all or a representation sample of
the underlying benchmark has worked well in the early stages of the development of the
market. However, institutional investors are increasingly demanding greater efficiency
and lower overall costs in the products that they hold and trade. This has lead to the
creation of a number of new ETFs which are based on index swaps as opposed to pure
equity holdings.
There are a number of benefits to be had from an ETF structured via a swap and overall
these types of ETFs have both significantly lower costs and tracking errors compared to
traditional equity ETFs. Swap-based ETFs remove the risks of managing dividend flows
compared to the index being tracked meaning that the problems of cash drag and dividend
receipt are no longer an issue. The same structure is also a more efficient means of
replicating total return indices, especially with relationship to funds where dividends are
sourced from a wide range of countries. Other costs that are faced by traditional ETFs
include index turnover due to index changes, rebalances and corporate actions.
Swap based ETFs can benefit overall performance
and costs
An index swap structure typically benefits a fund compared to owning the underlying
equities due to the fact that the returns are based on the benchmark index. Effectively the
index swap ensures that the ETF will have performance, before any management fees, at
least matching the designated index. In essence all the risks and costs associated with
running an ETF based on equities and measured against a total return benchmark are
passed onto the provider of the OTC swap. This means that a swap-based ETF by the very
nature of the returns that it now receives is likely to be considerably more efficient than
one based on the standard structure running the full basket of underlying equities.
The swap-based ETF framework has expanded from just the equity universe and now
covers ETFs in the fixed income, money market and credit space.
Creation / Redemption Process - Traditional ETF Structure
Secondary Market
Primary Market
Block trades
ETF fund
manager
The fund holds
stock with the
aim of
replication an
index
Creation / redemption
Creation / redemption
Creation / redemption
Designated
Sponsor
Designated
Sponsor
Designated
Sponsor
Institutional
and
alternative
investors
liquidity
Creation / redemption
ETF Segment
of equity
market
Designated
Sponsor
Buying and selling
of
ETFs
with
cash
Private
investors
Publication of NAV
Source: Deutsche Bank
Global
Portfolio & Index Strategy
5
Deutsche Bank
How to use ETFs
25 February 2008
The main benefits from swap-based ETFs are low tracking error and certainty relating to
costs, whilst investors also have the advantage of being able to take advantage of the
liquidity in the underlying stocks. A good example would be for a broad index such as
MSCI World. The underlying index has close to 1800 stocks, which an investor could own
as a fully replicated portfolio. However, this would tend to incur significant transaction
costs and would likely have substantial on going maintenance costs with respect to
corporate actions, takeover activity, dividend reinvestment and quarterly index rebalancing.
There are also multiple currencies to manage in the context of a World index.
Investors have long used futures baskets to replicate broad based benchmarks, but these
also have constant on going costs with respect to futures roll, margins, execution risk and
relatively high tracking errors. An optimal basket of 10 local futures gives a tracking error
of 153bps. If investors wish to have greater operational efficiency by using fewer futures,
the trade off is in the form of higher tracking error with, for example, four futures giving a
tracking error of 234bps.
In contrast to this, a MSCI World swap based ETF can be expected to underperform its
benchmark index by at most its total expense ratio of 45bps over the course of a year. In
addition the tracking is likely to be extremely low, with the tracking error of the db xtrackers MSCI World ETF having ranged from 1 to 3bps. Investors face similar levels of
efficiency with swap-based ETFs for broad benchmarks such as MSCI Europe and MSCI
Emerging World. In the case of MSCI Europe a typical futures basket would have a tracking
error of around 140bps, compared to 5bps for the ETF. With respect to the MSCI Emerging
Market World benchmark, futures are generally inefficient with tracking errors as high as
541bps whilst the ETF on the same index has a tracking error of 4bps.
The charts below show how swap-based ETFs offer tightly controlled risk and performance
relative to their benchmarks, with the low tracking error being a significant feature. Another
feature of the tracking error related to the futures baskets is that they tend to be very
unstable and subject to significant increases or decreases depending on levels of market
volatility. Swap-based ETF tracking errors are mainly a function of dividend factors relative
to the benchmark.
MSCI World Swap based ETF
Figure 12: Tracking Error
Figure 11: Relative Performance
3.50
1 0 0 .05
3.00
1 0 0 .00
9 9 .95
2.50
9 9 .90
2.00
9 9 .85
1.50
9 9 .80
1.00
9 9 .75
0.50
9 9 .70
J a n-0 7
0.00
M a r-0 7
M a y -0 7
J ul-0 7
S e p-0 7
No v -0 7
J a n-0 8
Mar-07
Apr-07
May-07
Jun-07
M S C I W orld - E TF NAV v Ne t TR Inde x
Jul-07
Aug-07
Sep-07
Oct-07
Nov-07 Dec-07
MSCI W orld - ETF NAV v Net TR Index
Source: Deutsche Bank, Reuters
Source: Deutsche Bank, Reuters
MSCI EM World Swap based ETF
Figure 14: Tracking Error
Figure 13: Relative Performance
4.50
10 0 .05
4.00
10 0 .00
3.50
9 9 .95
3.00
9 9 .90
2.50
9 9 .85
2.00
9 9 .80
1.50
9 9 .75
1.00
9 9 .70
0.50
9 9 .65
J un-0 7
J ul-07
Aug-07
Se p-07
O ct-0 7
Nov -0 7
M S CI E M W orld - E TF NAV v Net TR Index
D e c-0 7
0.00
Sep-07
Oct-07
Nov-07
Dec-07
MSCI EM W orld - ETF NAV v Net TR Index
Source: Deutsche Bank, Reuters
Source: Deutsche Bank, Reuters
6
Global
Portfolio & Index Strategy
Jan-08
25 February 2008
How to use ETFs
Deutsche Bank
Figure 15: Futures to Track MSCI World
Number of Contracts
5
4
Figure 16: Tracking Error of 10 futures basket
(MSCI World)
3
2
180.0
USA
EURO STOXX 50
JAPAN
UNITED KINGDOM
SWITZERLAND
AUSTRALIA
49.85
18.02
13.44
14.33
4.36
50.95
20.66
13.74
14.65
53.82
31.66
14.51
63.10
36.90
160.0
140.0
120.0
100.0
80.0
60.0
40.0
Tracking error
2.17
2.34
3.21
6.11
20.0
0.0
24-Dec-07
Source: Deutsche Bank, Reuters
07-Jan-08
21-Jan-08
Local market futures
04-Feb-08
18-Feb-08
Locals + EURO STOXX 50
Source: Deutsche Bank, Datastream
Figure 17: Tracking Errors
Some uses of Exchange Traded Funds
Tracking error sum m ary
The wide range of ETF products currently available within Europe should allow investors
to pursue a range of strategies. On the whole the majority of ETFs are based on families of
indices that generally fit into investors’ equity benchmarks with equity products based on
MSCI and STOXX dominating and with a comprehensive range of domestic country indices
from both Europe and other international markets. A wide range of iBoxx based ETFs also
dominate the fixed income space.
Developed Benchm arks
MSCI Europe
MSCI EAFE
MSCI Kokusai
MSCI World
Em erging Benchm arks
MSCI EM World
MSCI EM Europe
MSCI EM EMEA
MSCI EM Eastern Europe
Source: Deutsche Bank
1.40%
1.09%
1.31%
1.53%
Access to Low Cost Portfolio Diversification Opportunities
5.41%
7.82%
7.35%
8.61%
·
ETFs offer a wide range of portfolio diversification and asset allocation opportunities
·
Investors can easily gain exposure to asset classes that can otherwise be time
consuming and costly to manage and trade
·
Product transparency is ensured through weightings that are aimed at matching the
benchmark
·
ETFs cover all the asset allocation choices ranging from size, style, sector, and country
to regional
Gaining new asset exposure
ETFs are likely to gain increased usage as investors seek to gain exposure to particular
parts of the equity market. In this area ETFs, through the creation and redemption process,
may offer more trading opportunities than the listed derivatives market, mainly because
there are only a limited number of liquid listed derivatives.
Low cost access to otherwise difficult markets and
asset classes
One of the fastest growth areas has been for ETFs that cover areas and asset classes that
can be difficult and costly to trade and manage directly. This particularly applies to emerging
markets, be it individual countries in Asia or Europe to broad regions. The ability to trade
markets as diverse as Brazil, Russia, India and Vietnam using ETFs that trade on a developed
market exchange is appealing compared to the complexities of handling trading, settlement,
currency, corporate actions and custody in such markets.
Exposure to new strategies – short ETFs
One of the fastest growing areas in the ETF space relates to their use to gain exposure to
different strategies. In the US market, short-related ETFs now account for over 7% of all
daily turnover, with the recent high levels of intraday volatility being particularly helpful in
encouraging greater use of these products. In Europe, there is also a similar trend with
both higher turnover and new ETF issuance in the area of short and leveraged ETFs. The
main advantage to investors is that they can go long an ETF that creates positive returns
in a falling market. This can be significantly easier for many investors to manage than
either shorting futures or using a short OTC swap. A short-related ETF trades the same as
a long ETF and so is just as simple to trade whilst offering returns normally only associated
with a derivatives product.
Global
Portfolio & Index Strategy
7
Deutsche Bank
How to use ETFs
25 February 2008
Asset growth and turnover
One feature of the ETF market over the past few years has been that growth in assets
under management has significantly outpaced on exchange turnover. This shows quite
dramatically that whilst on exchange liquidity is a reasonable sign of product usage within
the ETF space, investors should pay just as much attention to the growth in assets under
management as these can demonstrate the more important trends underlying the market.
If one considers the European ETF market as a whole, over the past year assets have
grown from E69.8bn in January 2007 to E94bn, an increase of E24bn. Turnover for the
market as a whole has risen from an average of around E0.8bn to E1.97bn over the same
period. The charts below, of turnover and assets under management, show data for the
top 4 European ETF providers as well as aggregate data for the rest of the market.
The underlying dynamics of the marketplace though have also changed with swap-based
ETFs having become a significant portion of total assets. At the start of 2007 Lyxor had a
market share of 25.5%, whilst BGI on a combined basis, BGI and BGI (Deutschland), had
market share of 49.1%. As of February 2008, Lyxor’s market share had decreased modestly
to 24.7%, whilst the swap-based DB x-trackers platform had reached over 10%. Broadly
speaking swap-based ETFs now account for close to 35% of all assets under management.
Over the same period, on a combined basis, BGI’s market share remained the highest of all
providers at just over 40% of all AUM.
A useful indication of how asset growth can be independent of developments in on
exchange turnover Figure 20 shows the example of an Emerging market ETF. Since inception
in July 2007 the assets under management have grown from $18m to over $2.3bn. Over
the same period, aggregate on exchange turnover has only been $81m. This shows that
asset growth and product usage is not that tightly related to reported turnover and an
efficient creation and redemption process is a more important feature, especially when
considering broad-based ETFs. In the case of the Emerging Market World ETF shown, it is
now the 8th largest equity ETF in Europe in terms of assets.
Figure 19: MSCI EM World
Turnover and AUM trends
Figure 18: European Turnover
Main ETF issuers (Em)
700.0
12.0
2500
600.0
10.0
2000
500.0
8.0
1500
400.0
6.0
300.0
1000
4.0
200.0
500
2.0
100.0
0.0
Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07
Other 23 ETF issuers
Lyxor
Jul-07
BGI
Aug-07 Sep-07 Oct-07 Nov-07 D ec-07 Jan-08 Feb-08
BGI (Deutschland) AG
0
Jul-07
0.0
Aug-07
Sep-07
Oct-07
AUM ($m)
db x-trackers
Nov-07
Dec-07
Jan-08
Feb-08
Turnover ($m) RHS
Source: Deutsche Bank, Reuters
Source: Deutsche Bank, Reuters
Figure 20: European Asset Growth
Main ETF issuers (Ebn)
Figure 21: European AUM
Main ETF issuers Market Share
30.0%
25.0
25.0%
20.0
20.0%
15.0
15.0%
10.0
10.0%
5.0
5.0%
0.0
Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07
Other 23 ETF issuers
Lyxor
Jul-07
BGI
Aug-07 Sep-07 Oct-07 Nov-07 D ec-07 Jan-08 Feb-08
BGI (Deutschland) AG
Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07
Other 23 ETF issuers
Source: Deutsche Bank, Reuters
Source: Deutsche Bank, Reuters
8
0.0%
db x-trackers
Global
Portfolio & Index Strategy
Lyxor
Jul-07
BGI
Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08
BGI (Deutschland) AG
db x-trackers
How to use ETFs
Deutsche Bank
Fixed income ETFs
The past two years has seen a surge in activity in the fixed income ETF space with a
significant number of new ETFs that cover a broad spectrum of indices and maturities.
This phenomenon has been apparent in both Europe and the US although individual
market trends have differed.
In terms of assets under management the fixed income space has experience consistent
growth over the past two to three years with both the US and Europe at or close their peak
levels. In Europe assets under management (AUM) are around E17bn compared to around
E5bn at the start of 2006. In the US AUM have risen to around E25bn, which is almost
double the level from the beginning of 2006.
In Europe, the main growth in assets under management has been in the money market
space, especially over the past year, and these currently account for around 22% of total
assets. The largest area in terms of AUM in Europe is short duration ETFs. The dramatic
growth in money market ETFs in Europe has been in EONIA based products, however,
this success has also led to the launch of ETFs that cover both Fed Fund rates and
Sterling rates. Money market ETFs in Europe have become a dominant force due to the
uncertainty that has surrounded the asset quality backing institutional and retail funds.
In the US market, short duration ETFs are also the largest class in terms of AUM at over
30%of the total market. This is followed by a category that represents the broader bond
market and contains a wide mixture of total market and diversified bond ETFs ranging
from municipal bonds, high yield and total bond markets.
Figure 22: Fixed Income ETF AUM (Ebn) - US and Europe
30.0
25.0
20.0
AUM(Ebn)
25 February 2008
15.0
10.0
5.0
0.0
J un-03
D ec -03
J un-04
D ec -04
J un-05
E uro pe
D e c -05
J un-06
D e c -06
J un-07
D e c -07
US
Source: Deutsche Bank, Reuters
Figure 23: Fixed Income ETF AUM (%) by type - US and Europe
3 5 .0 %
3 0 .0 %
2 5 .0 %
2 0 .0 %
1 5 .0 %
1 0 .0 %
5 .0 %
0 .0 %
S h o rt
M is c
M e dium
L o ng
E uro p e
M o ne y
M a rke t
C o r p o r a te
In f la tio n
L inke d
C r e d it
US
Source: Deutsche Bank, Reuters
Global
Portfolio & Index Strategy
9
Deutsche Bank
How to use ETFs
25 February 2008
Currencies and commodities
Outside of the traditional equity and fixed income areas we expect that some of the most
significant growth in assets under management will be in the commodities and currency
areas. Commodity ETFs are likely to benefit from the focus on precious metals, agriculture
and energy as investment areas. In addition to this the creation of commodity based
strategy indices that offer managed exposure to a basket of commodities is also likely
bring about greater use of the related ETFs.
Currency as an asset class is an important emerging investment tool in terms of ETFs. As
a tool they provide investors with a simple listed product that trades efficiently and offers
consistent currency returns. Further to this, strategy based currency ETFs offer exposure
to dynamic active returns.
Conclusion
ETF usage is expected to grow substantially in the medium term as more innovative and
efficient ETF structures come to the market and offer more attractive performance
characteristics to institutional investors. In terms of overall cost comparison with traditional
ETF structures that own the underlying equity holdings we expect that swap-based ETFs
will bring enhanced returns to investors on a relative basis.
There has also been a dramatic expansion in the number of indices, styles and asset
classes covered by ETFs with a particular emphasis on country related products,
international country exposure, regional indices, sectors and more recently managed ETFs
that offer leveraged returns. Fixed income ETFs in Europe and the US have also been a
major growth area with a wide range of ETFs covering different maturities and strategies.
By providing investors with the broadest set of opportunities we believe that the ETF
market can offer competitive solutions. This is especially likely in an environment where
regulatory changes, such as the adoption of UCITS III, should benefit index-based products.
The fact that ETFs remain easy to trade and settle in comparison to competing derivative
and OTC instruments is likely to be a key factor in investor adoption of ETFs within their
portfolio strategies.
Investors are likely to derive the greatest benefit when using ETFs to gain exposure to
broad diversified benchmarks and indices.
10
Global
Portfolio & Index Strategy
25 February 2008
How to use ETFs
Deutsche Bank
Product Comparison
Comparison of ETFs and other products
Features
ETFs
Futures
Swaps
Classification
Fund
Derivative
Derivative
Liquidity
Depends on underlying liquidity,
generally very liquid.
Depends on underlying but
generally very liquid. Can trade
some contracts outside of cash
market hours
Depends on underlying
Cost of Investing
Management fee + cost of trading
Trading cost + roll costs if held
over an expiry - roll costs can be
positive
Traded costs embedded in index
strike price but may also have
'break' costs
Dividends
Generally paid out if not
reinvested: Payout formula:
(dividends - management fee +
percentage of lending profit)
Basis (risk): accounts for
dividends
Dividend enhancing potential
Voting rights
No voting rights
No voting rights
No voting rights
Risk Profile
Client faces the fund
Client faces the exchange
Client faces the issuer
Maturity
No maturity - can be created and
redeemed any day
Generally 3 months - can be
rolled into the next expiry
Generally betw een 1 and 3
years.
Redemption
Can be redeemed any time
against share portfolio or cash
Cash only - EFP market generally
very liquid - can create bespoke
EFPs
Cash only
Short selling
Can be sold short
Can be sold short
Can be created as a short
product
Borrow / Lending
Yes
n.a.
No
Index tracking
Responsibility of fund manager ie not guaranteed
Sw ap based offers pure index
tracking
Tracks index - dependent on
trading at fair value
Full index tracking
Market making
Generally more than one market
maker
Generally more than one market
maker
Issuer
Cost comparison
Cheapest:
If ETF is held long term (1 year
and over)
Cheapest:
If held for a short period
Cheapest:
For long term ow nership
Most Expensive:
ETFs that have high management
fees
Most Expensive:
Futures held over several rolling
periods depending on roll costs
Most Expensive:
If terms changed early
Accessibility
Everybody
Derivative investors only
Institutional
Management
Requires little attention and easy
from an accounting perspective
Requires attention each time a
contract expires
Requires little attention until
reset/maturity
Source: Deutsche Bank
Global
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11
Deutsche Bank
How to use ETFs
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Global
Portfolio & Index Strategy
25 February 2008
25 February 2008
How to use ETFs
Global
Portfolio & Index Strategy
Deutsche Bank
13
Deutsche Bank
How to use ETFs
25 February 2008
Appendix 1
Important Disclosures
Additional information available upon request
For disclosures pertaining to recommendations or estimates made on a security mentioned in this report,
please see the most recently published company report or visit our global disclosure look-up page on our
website at http://gm.db.com.
Analyst Certification
The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). In addition, the
undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view
in this report. Nizam Hamid
Regulatory Disclosures
Disclosures required by United States laws and regulations
See company-specific disclosures above for any of the following disclosures required for covered companies referred to in
this report: acting as a financial advisor, manager or co-manager in a pending transaction; 1% or other ownership; compensation
for certain services; types of client relationships; managed/comanaged public offerings in prior periods; directorships;
market making and/or specialist role.
The firm may trade as principal in the fixed income securities (or in related derivatives) that are the subject of this research
report.
The following are additional required disclosures:
Ownership and Material Conflicts of Interest: DBSI prohibits its analysts, persons reporting to analysts and members of their
households from owning securities of any company in the analyst’s area of coverage.
Analyst compensation: Analysts are paid in part based on the profitability of DBSI, which includes investment banking
revenues.
Analyst as Officer or Director: DBSI policy prohibits its analysts, persons reporting to analysts or members of their households
from serving as an officer, director, advisory board member or employee of any company in the analyst’s area of coverage.
Distribution of ratings: See the distribution of ratings disclosure above.
Price Chart: See the price chart, with changes of ratings and price targets in prior periods, above, or, if electronic format or
if with respect to multiple companies which are the subject of this report, on the DBSI website at http://gm.db.com.
Additional disclosures required under the laws and regulations of jurisdictions other
than the United States
The following disclosures are those required by the jurisdiction indicated, in addition to those already made pursuant to
United States laws and regulations.
Analyst compensation: Analysts are paid in part based on the profitability of Deutsche Bank AG and its affiliates, which
includes investment banking revenues
Australia: This research, and any access to it, is intended only for “wholesale clients” within the meaning of the Australian
Corporations Act.
EU: A general description of how Deutsche Bank AG identifies and manages conflicts of interest in Europe is contained in
our public facing policy for managing conflicts of interest in connection with investment research.
Germany: See company-specific disclosures above for (i) any net short position, (ii) any trading positions (iii) holdings of five
percent or more of the share capital. In order to prevent or deal with conflicts of interests Deutsche Bank AG has implemented
the necessary organisational procedures to comply with legal requirements and regulatory decrees. Adherence to these
procedures is monitored by the Compliance-Department.
Hong Kong: See http://gm.db.com for company-specific disclosures required under Hong Kong regulations in connection
with this research report. Disclosure #5 includes an associate of the research analyst. Disclosure #6, satisfies the disclosure
of financial interests for the purposes of paragraph 16.5(a) of the SFC’s Code of Conduct (the “Code”). The 1% or more
interests is calculated as of the previous month end. Disclosures #7 and #8 combined satisfy the SFC requirement under
paragraph 16.5(d) of the Code to disclose an investment banking relationship.
Japan: See company-specific disclosures as to any applicable disclosures required by Japanese stock exchanges, the
Japanese Securities Dealers Association or the Japanese Securities Finance Company.
14
Global
Portfolio & Index Strategy
25 February 2008
How to use ETFs
Deutsche Bank
Russia: The information, interpretation and opinions submitted herein are not in the context of, and do not constitute, any
appraisal or evaluation activity requiring a licence in the Russian Federation.
South Africa: Publisher: Deutsche Securities (Pty) Ltd, 3 Exchange Square, 87 Maude Street, Sandton, 2196, South Africa.
Author: As referred to on the front cover. All rights reserved. When quoting, please cite Deutsche Securities Research as
the source.
Turkey: The information, interpretation and advice submitted herein are not in the context of an investment consultancy
service. Investment consultancy services are provided by brokerage firms, portfolio management companies and banks
that are not authorized to accept deposits through an investment consultancy agreement to be entered into such corporations
and their clients. The interpretation and advices herein are submitted on the basis of personal opinion of the relevant
interpreters and consultants. Such opinion may not fit your financial situation and your profit/risk preferences. Accordingly,
investment decisions solely based on the information herein may not result in expected outcomes.
United Kingdom: Persons who would be categorized as private customers in the United Kingdom, as such term is defined
in the rules of the Financial Services Authority, should read this research in conjunction with prior Deutsche Bank AG
research on the companies which are the subject of this research.
This note is not intended to promote or offer any ETF in any jurisdiction in which an offer, solicitation,
purchase or sale of such fund would be unlawful under the securities laws of such jurisdiction.
This document is for general information purposes only and does not constitute an offer to sell any ETFs or an invitation or
recommendation to enter into any transaction. The full terms and conditions of any ETFs can be obtained free of charge
from your investment advisor. This document is issued by Deutsche Bank and the distribution of this document in certain
jurisdictions may be restricted by law.
ETFs may not be a suitable investment for you and can involve important legal and tax consequences and investment risks.
We strongly recommend you to consult your financial advisor prior to investing in ETFs.
Please consult the appropriate ETF Offering Circular for full details and before any investment is made.
Disclaimer
The information contained in this document has been derived from sources believed to be accurate and reliable. Deutsche
Bank AG has not independently verified any information contained in this document. Accordingly, neither Deutsche Bank
AG nor any other member of the Deutsche Bank Group gives any representation or warranty of reliability, completeness or
accuracy of such information. This information should not be construed as an offer, invitation or solicitation to subscribe,
purchase or sell any of the financial products listed here, nor does it constitute investment advice or a recommendation to
enter into any transaction that would form whatsoever the basis of any contract or commitment. This document is intended
for non-private customers resident in the EEA or Switzerland. Deutsche Bank AG or one of its affiliates may make a market
in one or more of the ETFs mentioned in this document.
Global
Portfolio & Index Strategy
15
Deutsche Bank
How to use ETFs
25 February 2008
Deutsche Bank Global Markets Research
David Folkerts-Landau
Managing Director
Global Head of Research
COO/Regional Management
Global Company Research
Global Fixed Income Strategies
Global Equity Strategies &
& Economics
Quantitative Methods
Ross Jobber
Guy Ashton
Marcel Cassard
Stuart Parkinson
Chief Operating Officer
Head of Global Company
Head of Global Fixed Income
Head of Global Equity Strategies
Research
Strategies & Economics
& Quantitative Methods
Regional Management
Pascal Costantini
Andreas Neubauer
Michael Spencer
Karen Weaver
Regional Head Europe
Regional Head Germany
Regional Head Asia Pacific
Regional Head Americas
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This published research report may be considered by Deutsche Bank when Deutsche Bank is deciding to buy or sell proprietary positions in
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16
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