EXCHANGE-TRADED FUNDS

JANUARY 31, 2013

What is an Exchange-Traded Fund?

Investment fund traded on stock exchanges, much like

stocks Underlying assets / securities

Stocks Commodities

Bonds
Currencies

Available in U.S. since 1992 and in Europe since 1999 Not yet available in the Philippines but theres a plan to

introduce this

Advantages of ETFs
Exchange-traded ETFs can be bought and sold throughout the trading day No investment minimum ETFs can be bought in quantities as small as one share Lower expense structure Most ETFs are index funds thus having naturally lower management expenses Shareholding servicing costs are lower because they are exchange-traded

Advantages - ETFs
Broader set of investments ETFs allow investors to have access to commodities and currencies which traditional mutual funds are generally not permitted to own Tax efficiency ETFs are more tax-efficient than many mutual funds (generate fewer taxable capital gain)

Disadvantages - ETFs
Trading commissions Investors in ETFs must normally pay brokerage commissions whenever they buy or sell shares Fewer choice of actively managed funds Most ETFs are passive index funds; actively managed ETFs are just beginning to be developed

How Do ETFs Operate?

ETFs dont deal directly with their shareholders

Creation and redemption of shares are done through an

authorized participant

How Do ETFs Operate?

Step 1. The authorized participant assembles a creation

basket, a portfolio of securities that exactly matches the portfolio of securities held by the ETF. Step 2. The AP delivers the creation basket to the ETF. In exchange, it receives a creation unit, which is a large batch of shares of the ETF.
Step 1

ETF
Step 2

Authorized Participant

Exchange

Investors

How Do ETFs Operate?

Step 3. The AP breaks the creation unit down into smaller

sets of shares and sells them in the public market or the AP may decide to hold on to some or all of these shares.

Step 1

Trading

ETF
Step 2

Authorized Participant

Exchange
Step 3

Investors

How Do ETFs Invest?

Investment Strategy is determined if it is going to be: Index-based (Passive)
Replication a fund buys exactly the same securities as the index Sampling a fund buys only a carefully selected subset of the index

stocks Aggressive approach

Inverse or Short ETFs Leverage ETFs

Actively managed
To put ETFs on equal footing with mutual funds

Current State of ETFs

ETFs have appealed largely to wealthier individuals and

institutional investors.

HEDGE FUNDS

What is a Hedge Fund?

Private, actively managed investment fund that seeks to

provide returns to their investors by investing in a diverse range of markets, investment instruments, and strategies. Exempt from many of the regulations governing mutual funds. Hedge funds can:
Invest in a wide variety of assets
Require investors to remain in the fund for months or years at a

time Use large amount of borrowed money or leverage to enhance investment returns Engage extensively in short sales Charge performance fees based on gains on top of management fees on assets

Advantages of Hedge Funds

1. Alpha or above market returns

2. Absolute returns
3. Lower volatility 4. Low correlation 5. Unique strategies and assets 6. Star management talent 7. Manager co-investment

Hedge Fund Strategies

Equity long-short Buy undervalued stocks Short overvalued stocks Arbitrage Buy shares of a company in the process of being acquired Short share of the acquirer Distressed Shareholder activism Leverage

ACTIVE VS. PASSIVE INVESTING

Which can give you superior return in the long run? Why?