Exchange traded funds (ETFs) are gradually drawing the interest in the Gulf countries, albeit relatively new in the region. Generally, professional investors (wealth advisors) view ETFs as liquid, transparent and low cost investment tools that help construct portfolios. Yet, many people do not know what an ETF actually is, let alone how it is used, said Barclays Global Investors - one of the world's largest asset managers and a leading global provider of investment management products and services. “Here we seek to demystify what is a relatively simple but powerful product category and how you can use it to augment your portfolio,” its office in Dubai said. Accordingly, GCC based investment professionals are using ETFs in multiple ways. One of the key uses for ETFs is combining different asset classes in the “core” of investment portfolios with actively managed funds or single stock selections. The result is a blend of active and passive management that can be tailored to best fit an optimal asset allocation and a client's risk profile. GCC based professional investors are also significant users of ETFs for tactical trading strategies, which typically include specific sector, single country or emerging market ETFs. ETFs are frequently used as a means to gain immediate exposure to a market. Instead of investing new cash flows in money market funds or government bond futures while making investment decisions, or waiting for new issuance, a portfolio manager can now buy diversified exposure to the corporate or government bond market through a number of recently launched ETFs. ETFs represent a simple proposition - an ETF is an investment vehicle which is constructed like a mutual fund but trades like an individual security on a stock exchange. Essentially, an ETF combines many of the benefits of traditional mutual funds, but are not to be confused with close-ended mutual funds that also trade on an exchange. ETF units can be created or redeemed by Authorized Participants as required and as ETFs are listed on stock exchanges just like a share, they can be traded whenever the exchange is open. Unlike many other types of funds, there is no fund manager picking the underlying stocks. Instead, the investor is given exposure to whichever companies make up the index that the ETF is tracking. As with all investments the value of a holding in ETFs could go down as well as up and an investor may not get back the amount invested. Globally, ETFs have seen a tremendous uptake since they were first introduced to the market in 1993 with 3 products covering US$0.8 million assets under management (AUM). At the end of Q2 2009 the Global ETF industry had 1,707 ETFs with 3,066 listings, assets of $789.04 billion, from 93 providers on 42 exchanges around the world with plans to launch an additional 777 new ETFs. Globally, iShares is the largest ETF provider in terms of number of products, 386 ETFs, and assets of US$380.23 billion, reflecting 48.2 percent market share1. Active fund mangers typically maintain a cash buffer of between 1 percent and 3 percent of a fund's total assets in order to effectively meet client redemptions. Conversely, new investments into a fund can generate a cash balance that might exceed the desired weighting. In both instances, an efficient way to minimise the ‘cash drag' effect, or the loss of performance that can result from holding cash rather than equities, could be holding an ETF. Some may argue that investors can already use futures to accomplish this goal. However, there are some areas where there are no liquid futures available, for example if an investor is trying to gain access to a broad emerging market index. Many investors use core-satellite investing to meet very specific risk and return requirements. Core-satellite investing is based on the simple concept of splitting a portfolio into two segments. The first is the core which forms the foundation of the strategy around which the more specialized satellite investments can be added. The core investments account for the main part of the overall portfolio, a typical allocation to the core investments would be 70 percent. The core usually takes the form of a lower risk, pooled investment vehicle. This is typically an index tracking fund, such as an ETF, that offers low cost, broadly diversified exposure to a market or index. The aim is to deliver a return in line with the market's performance - this is often referred to as the beta return. One of the most important factors in implementing such a strategy is cost, as pursuing a variety of investment strategies runs up management fees that erode the portfolio's returns. ETFs mitigate this cost problem, with funds that track major indices like the S&P 500, FTSE 100 and EuroStoxx 50 making ideal core components of the overall portfolio. ETFs charge no sales or redemption fees and annual fund expenses can be as low as 0.09 percent. The second segment of a core-satellite portfolio is made up of the satellites. These are typically more specialized investments which the portfolio manager believes will deliver additional returns. This can be achieved through exposure to specific markets, actively managed funds, investment themes, individual securities and ETFs. Satellite investments typically carry higher risk and fees than core investments. While broad based ETFs make ideal core holdings, more specialised funds also make excellent satellite investments where managers are expressing their views on the market at the periphery of the portfolio to generate additional returns. The range of ETFs available offers significant choice with large and smaller companies, as well as value and growth market segments covered. Most investors would concede that while they are experts in their specialist area of investment, they might not have the level of knowledge required to make informed decisions in areas with which they are less familiar. Indeed, in some areas they may not have adequate research to fully justify an investment decision at the security level. Buying into an appropriate ETF would provide a solution as security specific risk is eliminated. The investor's view can be translated into a holding rapidly and easily, while the resulting diversification is a clear benefit over As ETFs are extremely liquid and inexpensive to trade, they make efficient hedging tools. For example, if a portfolio manager takes a short-term negative view on a market, or needs to hedge a portfolio against the impact of a specific event, he can sell an ETF to reduce exposure to an asset class or specific market. This is far simpler and less expensive than deconstructing a carefully planned portfolio, and then buying all the securities back when the hedge is lifted. ETFs can be traded real time through a stock exchange rather than the once per day trading that many other types of funds typically offer. Developed markets have seen an unprecedented volatility over the past year, with markets routinely swinging as much as 6 percent intra-day. Accordingly, investors are no longer content to wait for end-of-day pricing provided by traditional mutual funds, when they know they can implement investment decisions with ETFs immediately. Irregular and unforeseen events offer tactical short-term opportunities to add value. One route to implementing such a short-term view, before the opportunity is arbitraged away, would be to select a basket of individual securities. However, this would require a number of security specific decisions and trades. Therefore, in many instances using an ETF to express this type of view is a more effective option to gain exposure to a selection of securities through a single trade.
