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What exactly are exchange-traded funds?

Mar 16, 2022.

In the third article in the «Investing Money» series, we explain what an exchange-traded fund is, what the benefits of this investment instrument are and what you need to be aware of in terms of costs.

An exchange-traded fund, or ETF for short, is an extremely low-cost investment instrument that can be traded continuously on the stock exchange like shares. Unlike other investment funds, no issuing commission is charged on a purchase, just the brokerage fee, as is the case with any direct purchase of securities. As special funds, ETFs are subject to public supervision and do not entail any issuer risk. The range of funds on offer is constantly being expanded: there are ETFs for individual sectors (such as energy or technology), regions (emerging markets) and commodities (such as gold), and those geared to specific investment strategies (pure bond ETFs, pure equity ETFs). 

 

THE BENEFIT OF ETFS

ETFs are often very cheap – on average more than 1% cheaper than actively managed funds – which is true year for year because no active management is necessary. ETFs enable investors to invest, for instance, in core indices such as SMI, SPI, S&P500 and EuroStoxx50.

 

Like other funds, ETFs are subject to supervision by the Swiss Financial Market Supervisory Authority FINMA. The Swiss stock exchange must also ensure that fair buying and selling prices are offered for every ETF at all times.

 

the cost of funds

The costs of a fund are usually reported by the provider in the form of a key indicator, the Total Expense Ratio (TER), as a percentage of the invested capital. 

 

The TER does not include all costs – even though the name might suggest it does. What it includes and what other costs are involved is shown in the following box.

 

TER and other costs

The TER includes the following items:

  • Management fee: for an equity fund, this can sometimes be over 2%; for a cheap ETF, it is in the range of only tenths of a percentage point.
  • Custodian bank fee: this fee is charged by the fund bank. As a rule, it is less than 0.3% of the fund assets per year.
  • Costs for business operations: for fund prospectuses, auditors, advertising campaigns, etc.

 

Three other items are not included in the TER:

  • Issuing commission: a one-off purchase fee that you have to pay when buying a fund. Usually, the fund companies specify a maximum percentage that the distribution companies may charge in the documents. This is often around 5%.
  • Redemption commission: when you sell your fund units back to the fund company, you often have to pay a fee.
  • Custody account fee: this is the fee you pay for your own custody account. It is around 0.2% of the value of the securities deposited.

 

Note: To find the right ETF for you, we strongly advise you to compare different products with each other and check them for items that are not included in the TER.

 

Choosing the right fund

A fund’s rating is an important selection criterion. There are a number of specialist fund analysis firms that check the quality and performance of funds and award stars, such as Morningstar and Sustainalytics.

MORE ARTICLES ON THE SUBJECT

Would you like to learn more about sustainable investment? Then we recommend the article «ESG: How to change the world with three letters».

ABOUT THE AUTHOR

Raphaël Savary has been passionately pursuing his career for 13 years. He holds a Federal Diploma of Higher Education in Financial Planning and is Sales Manager at Generali in the Lausanne-Riviera region. Thanks to his holistic analytical approach and 360° view, he helps Generali clients to optimise their operations from all angles in the areas of insurance, finance and pensions.

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