What are the Types of ETFs?

What are the Types of ETFs?
TradeGM Analysis date_range May 10th, 2021

Have you ever wondered what ETFs have to do with synthetic replication and what the abbreviations TER, TCO and TE stand for? Here’s a compilation of all the terms and expressions used in the industry to discuss ETFs and investments funds. 

What is a Distributing or Accumulating ETF? 

Index funds, including exchange-traded funds (ETFs), can be distributing or accumulating. As the name suggests, distributing ETFs and mutual funds distribute stock dividends, bond interest, and other income on a regular basis. On the other hand, accumulating ETF reinvests the dividend or interest back into the fund. Investors thus benefit from a kind of compound interest effect since the assets increase not only as a result of the amounts paid in and the price gains but also the income generated. Depending on your investment strategy, you should choose the type of ETF that best suits your goals.  

What is a Replicating ETF? 

All ETFs replicate an index. There are two ways to replicate the underlying index: physical replication and synthetic replication.  

A physical ETF replicates an index by actually buying the stocks in the index  – this is known as direct replication. If the ETF provider actually buys all of the securities in the index, then this is called full replication. Some issuers buy and sell only those stocks listed in the index that have a heavy influence on the index performance. This is called sampling or optimized sampling. However, this approach can more easily lead to discrepancies in price performance between the ETF and the index. 

Synthetically replicating ETFs do not buy the securities included in the underlying index. Instead, they use financial engineering to replicate the return of a selected index. They replicate the index performance by using derivatives such as swaps. The swap transaction (also known as a swap agreement) is a derivative transaction conducted between the ETF provider and a swap counterparty.  

The swap transaction works like this: Investor funds held in a synthetic ETF are invested in a basket of securities. This serves as collateral for the swap transaction. The securities in the collateral portfolio do not necessarily have to match the securities of the index being tracked. Thus, a synthetic ETF on the MSCI Europe can also contain American stocks in the collateral portfolio. The swap counterparty pays the ETF the index return, including all dividend payments. In exchange, it receives a ‘swap fee’ and the return of the securities in the collateral portfolio. 

So, which one is better? 

Synthetic replication is cheaper than physical buying and selling, but the risk is higher than with direct replication. If the swap counterparty becomes insolvent, investors may lose their entire deposits. 

What is TER, TCO, TE, and TD? 

The total expense ratio, or TER, makes it very easy to compare fees among funds. The TER provides an initial indication of the costs involved in investing in a particular fund or ETF. However, not all costs are reflected in the TER. The TER only indicates the annual ongoing costs of owning a fund. 

The TCO, or total cost of ownership, is better. The TCO indicates the actual total cost of owning a fund and takes into account, for example, the swap fee for synthetically replicated ETFs, trading fees, and spreads for transactions within an ETF, as well as taxes and income. 

To get a full picture of your investment expenses, you should also pay attention to the indirect fees generated by tracking error (TE). It measures the ETF’s deviation from the underlying index. If the TE is low, then the performance is very similar compared to the index. However, it is essential to note that the TE does not indicate whether the deviation is positive or negative; this is revealed by the Tracking Difference (TD). The TD indicates the difference between the return of the ETF and the return of the index that is tracked by the ETF. 

Legal disclaimer: The material does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instruments. Ebrókerház Ltd accepts no responsibility for any use that may be made of these comments and for any consequences resulting in it. No representation or warranty is given as to the accuracy or completeness of this information. Consequently, any person acting on it does so entirely at their own risk. The information presented does not involve any specific investment objectives, financial situation, and needs of any specific person who may receive it. Past performance does not constitute a reliable indicator of future results and future forecasts do not constitute a reliable indicator of future performance.

Please consider that no news or information shared, nor any content included in any other document available in this website, should be understood in any way, either explicitly or implicitly, directly or indirectly as investment advice, recommendation, or a proposal for an investment strategy related to a financial instrument, as these are made available to you solely for information purposes. The data and information disclosed in the news or in the website, or the analyses attached to trading charts, only reflect the result of a technical analysis done by a professionally independent third party and may change without any prior notice.

The clients of eBrókerház Befektetési Szolgáltató Zrt. open orders through the Trade GM Trader Online Trading Platform, the orders will be forwarded to an execution venue defined in our Execution Policy. Trade GM Trader Online Platform is operated by eBrókerház Szolgáltató zrt, which is authorized and regulated by the Hungarian National Bank under the licence numbers III/73.059/2000. and III/73.059-4/2002.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75.42% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. The materials contained on this page are for advertising and marketing purposes only and should not in any way be construed, either explicitly or implicitly, directly or indirectly. as investment advice, recommendation or suggestion of an investment strategy with respect to a financial instrument, in any manner whatsoever. You should make sure that you have sufficient time to manage your investments on an active basis. CDF are derivative financial instruments, which price is derived from the price of the underlying asset or contract to which the CFD refers (for example currencies, commodities, indices, equity, etc.). Derivative financial instruments and related markets can be highly volatile. The prices of CFDs and underlying instrument may fluctuate rapidly over wide ranges and may reflect unforeseeable events or changes in conditions, none of which can be controlled by the client or eBrókerház Befektetési Szolgáltató Zrt. Prices quoted or information may vary and change depending on market conditions. When investing in Company’s Products denominated in a currency other than that of the state in which you reside, the return may increase or decrease as a result of currency fluctuations. Any indication of past performance or simulated past performance included in an advertisement is not a reliable indicator of future results. All names, pictures and personal details of people depicted as traders in advertisements concerning past performance are included for presentation purposes only, and are not the actual traders who have made the transaction detailed in the advertisement (actual details are kept for privacy purposes). All opinions expressed by traders are not actual testimonials but rather are depictive of the actual past performance and trading experience. Any trades depicted are selected from past real successful trades and are not reliable indicator of all customers past or future trades.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75.42% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. X