What are ETFs?

The term “ETF” often comes up in the context of online wealth management in association with words such as “transparent”, “secure” and “low costs”. In this article, we provide a (hopefully) easy-to-understand explanation of what is behind these three letters and the advantages of this investment product.

ETF stands for “exchange-traded fund”. ETFs track the performance of the market. Every ETF tracks a certain index, which in turn replicates the performance of a set of securities. The Swiss Market Index (SMI), for example, represents the performance of the largest Swiss companies.

What are the advantages of ETFs?

The increasing popularity of ETFs is due in particular to the following advantages:

  • Low costs: one advantage of ETFs is that they are well suited to investors with smaller amounts of savings due to the low product costs.
  • Low risk: the units in which an ETF invests are broadly diversified. Broad diversification always means lower risk and higher security.
  • Flexibility and simplicity: since ETFs are traded on exchanges, they are available for trading at all times. In addition to their flexibility, ETFs also have low administration costs.
  • Transparency: because ETFs replicate an index, investors have an overview of which equities, securities or commodities they have invested in at all times.

ETFs are affordable

The fees for ETFs are reflected in the total expense ratio (TER), which includes trading costs and the management fee. Some ETFs have a TER of less than 0.1%, making them highly attractive in terms of costs. Why is this the case?

With ETFs, you are pursuing a passive investment strategy

ETFs pursue a passive investment strategy. This differs from the active approach of a fund manager who attempts to beat the index, i.e. to achieve a higher return than the market index. The main advantages of the passive approach are the lower costs. The product costs of the active approach are higher, primarily due to the services provided by the fund manager. According to studies, however, fund managers cannot beat the benchmark index over an extended period of time.

Why is the risk lower?

As mentioned above, ETFs invest in multiple securities, thereby diversifying the risk in the same ways an investment fund. In contrast to investment funds, however, ETFs can be traded on the stock exchange just like equities.Unlike equities, ETFs replicate the index as closely as possible and invest in equities, bonds, real estate and commodities – in other words in all possible asset classes.

How can you buy ETFs?

All you need to buy ETFs is a custody account with a bank. Since the risk of an ETF is already diversified, you do not need to worry about achieving the right distribution. Unlike with equities, you choose an ETF that suits your investment strategy and then remain invested in it without any further administrative work being required. With an online wealth management company like ELVIA e-invest, experts take care of the choice of your ETFs.

What distinguishes a good ETF?

The choice of the right ETF is key to an investment’s success. The selection process is primarily based on the chosen investment strategy. How much return does the investor want to generate?

How much risk is he or she willing to take? At ELVIA e-invest, we clarify all these questions before beginning the ETF selection process.

Quality features of an ETF

Once you have chosen your investment strategy, other criteria determine an ETF’s quality and probability of success. These include, for example, how long the ETF has been on the market and what fund volume it contains.

The fund volume reduces the likelihood of an ETF being liquidated, i.e. disappearing from the market. In addition, some ETFs have lower total costs.

  1. Tracking quality

    That is not everything, however: an ETF should have a good tracking quality. This means that it should replicate the index as faithfully as possible to ensure that the difference in the return is not too great. Low tracking quality has disadvantages in terms of costs for the investor.

  2. Performance and fund domicile

    Furthermore, historical performance should be examined carefully and the market in which the ETF invests should be assessed. ETFs differ in terms of fund domicile, for example, which results in varying risks and costs.

  3. Accumulating and distributing ETFs

    Then there is the question of whether to opt for accumulating or distributing ETFs. Distributing ETFs are suitable for short-term investments as returns are paid out directly. Accumulating ETFs on the other hand generate higher returns over an extended period because they reinvest returns.

  4. Physically and synthetically replicated ETFs

    In the case of physical ETFs, there is no issuer risk as the equities are bought by the ETF provider, meaning that they are physically replicated.  By contrast, synthetic ETFs use swaps to replicate the index. Although investors in synthetic ETFs can also be protected against issuer bankruptcy, checking this requires a good level of expertise and a significant amount of work.

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