Abstract
This chapter outlines the most important formal and investment characteristics of ETFs. It discusses legal aspects regarding these financial instruments, in relation both to the US market and to other highly developed financial markets. This is followed by the issues that are in the spotlight of the investors and advisors using ETFs, related mainly to index-tracking. Among them, there are presented the two basic methods of index replication—physical (direct) and synthetic (swap-based), as well as securities lending. Additionally, there are also thorough characteristics of various types of risk faced by investors, resulting from index-tracking and securities lending, as well as the presentation of costs associated with these practices.
This is a preview of subscription content, log in via an institution to check access.
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
Notes
- 1.
According to some authors (e.g., Kupiec [1990], Gastineau [2010], and Seddik Meziani [2016]), the first financial products with features similar to exchange-traded funds as we know them today were Index Participation Shares (IPS). Two types—Equity Index Participations (EIPs) and Cash Index Participations (CIPs)—were briefly traded in 1989, respectively, on the American Stock Exchange and on the Philadelphia Stock Exchange. These “basket” financial instruments were meant to be a relatively simple proxy for the S&P 500 Index and were simultaneously traded on stock exchanges, like stocks. IPS were hybrid instruments that had some characteristics similar to those of existing index-futures contracts, index options contracts, and index mutual funds (Kupiec 1990).
- 2.
- 3.
In fact, ETF trading is—in many aspects—different from stock trading. More information on these differences and various aspects of ETF trading will be presented in the next chapter.
- 4.
However, ETFs must receive exemptive relief from the Securities and Exchange Commission (SEC) from certain provisions of the 1940 Act. This structure, like the other structures in the USA, is subject to the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act). In September 2019, the Securities and Exchange Commission adopted a new rule (Rule 6c-11) and formed amendments that are designed to modernize the regulation of ETFs, by establishing a clear and consistent framework for the vast majority of ETFs in the USA. The rule provides several exemptions from the 1940 Act to permit ETFs to form and operate without the need to obtain individual exemptive relief from the SEC.
- 5.
According to Morningstar calculations, as of June 30, 2018, as many as 98% of US ETFs (considering their assets) are organized and regulated as registered investment companies (RICs) under the US Investment Company Act of 1940 (Vanguard 2019).
- 6.
Directive 2009/65/EC of the European Parliament and of the Council of July 13, 2009, on the coordination of laws, regulations, and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) (with amendments). UCITS funds may be constituted in accordance with contract law (as common funds managed by management companies), trust law (as unit trusts), or statute (as investment companies).
- 7.
According to Morningstar estimates, 91% of European-domiciled ETFs, considering their assets, are organized and regulated as registered investment companies under the UCITS Directive (as of September 30, 2015) (Vanguard 2016). European ETFs that are not regulated by this Directive operate in countries outside the European Union (mainly in Switzerland) as well as in some other EU member states where they are regulated by national law (e.g., in Poland).
- 8.
In such a legal form first and biggest ETF in the USA operates—the SPDR S&P 500 ETF Trust.
- 9.
More information about different ETF structures in the USA—with regard to legal and tax considerations—can be found in Vanguard (2015).
- 10.
A review of various structures of such financial instrument is presented by Stevenson (2010).
- 11.
The Israeli ETF reform known as the “28th amendment” was completed in the last quarter of 2018. As a result, most of the 714 ETNs listed on the TASE in August 2018 were turned into ETFs.
- 12.
According to PricewaterhouseCoopers (2019), European domiciled ETFs have been registered for distribution in 24 European countries, 4 Asia-Pacific countries, 4 countries in the Americas, 2 Middle Eastern countries, and one African country (as of end June 2019).
- 13.
More information about trading ETFs in international markets will be presented in the next chapter.
- 14.
The first indexed mutual fund (the Qualidex Fund) was launched in 1972. The first institutional indexed funds were created by Wells Fargo (Wells Fargo Stagecoach Fund) and American National Bank together with Batterymarch in 1973. The first retail index fund commenced in 1975 (the Vanguard 500 Index Fund).
- 15.
- 16.
It is worth noting that, although ETFs were invented as strictly passive investment vehicles, in the following years they were used as a financial instrument that enabled the seamless combination of a passive and active investment approach (the first ETF smart beta was launched in 2000) and as a tool for active management (the first active ETFs appeared in 2008). What is more, recent momentous changes on the US ETF market, i.e., the creation at the beginning of 2020 of the first so-called non-transparent (or semi-transparent) ETFs, means that these instruments are, in practice, becoming a “wrapper” that will find a number of new, not just standard, passive applications.
- 17.
The genesis of the theoretical idea of passive investing can be traced to the 1960s, when famed Chicago economist and Nobel laureate Eugene Fama created the foundations for the Efficient Market Hypothesis (EMH). However, the precise description of the academic issues related to passive investing goes beyond the scope of this book (some of them were discussed in Chapters 1 and 2). They have been described in, e.g., Ferri (2011), Stevenson (2010), and Seddik Meziani (2006).
- 18.
According to ETFGI (2019), assets of actively managed ETFs and ETPs amounted to USD 151.2 billion, which at the end of November 2019 accounted for nearly 2.5% of total assets invested globally in ETFs and ETPs.
- 19.
It is worth emphasizing, that this issue looks different in the case of ETFs that replicate so-called smart beta (or strategic beta or enhanced) indexes. The term “smart beta” (often considered to be a strictly marketing term) refers broadly to a group of indexes (and indirectly also to ETFs and other financial products tracking them), which are created—often on the orders of financial institutions who intend to offer products based on them—to deliver enhanced returns or minimize risk relative to traditional (capitalization-weighted) benchmarks. These indexes may aim to capture a specific factor or set of factors such as value, momentum, small size, low volatility, quality, etc.
- 20.
Some managers of equity funds—contrary to the declarations and promises given to investors—rarely take bets on the market in practice. It means that the composition of the fund’s investment portfolio largely overlaps the benchmark portfolio—taking into account both stocks in the portfolio and their weights. When such an investment approach is accompanied by the simultaneous charging of a relatively high management fee (at the level close to the actively managed funds) this is referred to as closet indexing (closet tracking). This unethical practice, which seriously harms investment fund clients, has been the subject of interest and studies for researchers, supervisory authorities, and institutions that represent the interests of financial services users for several years in many countries (especially in European). More information on closet indexing in Europe can be found in, e.g., SCM Direct (2015), ESMA (2016), and Better Finance (2017).
- 21.
Reconstituting an index is the practice of adding or deleting securities to/from the index. Decisions are based on whether these securities (e.g., stocks in equity indexes) meet the index criteria or not. In rules-based indexes, it refers to, e.g., free-float market capitalization and liquidity. Reconstitution is also required to reflect the changes in the securities value (driven, for example, by mergers or acquisitions, delisting, or bankruptcy). In turn, in discretionary indexes, these decisions are the result of the subjective view of members of the index committee. The frequency of reconstitution can be different—the more often it is carried out and the more shares it deals with, generally, the more difficult it is to achieve high quality of index replication (in physical replication) due to possible problems with the purchase or sale of shares in a short time (especially on low-liquid markets or segments) and due to the increase in transaction costs.
- 22.
Rebalancing an index is the practice of adjusting the weight of securities in an index portfolio according to the methodology used in creating the index on a regularly scheduled basis (usually quarterly). The change in the market price of securities (index constituents) in a specific period necessitates rebalancing and leads to buying and selling securities by index investors, including ETFs. This, in turn, may (as in reconstitution) cause problems with the accuracy of the index replication. That is why index providers must balance the desire to achieve index accuracy and its representativeness with the requirement to avoid unnecessary index turnover. In capitalization-weighted indexes, turnover that results from changes in relative company size can be reduced by applying “buffer zones” to capitalization bands that define eligibility for particular sizes of segments.
- 23.
There are different definitions of this kind of event. For example, FTSE Russell defines a corporate action as an action on shareholders with a prescribed ex-date (e.g., rights issue, special dividend and share split), while a corporate event as a reaction to company news that might impact the index, depending on the index ground rules (e.g., a large sale of shares by a strategic shareholder which impacts a company’s free float) (FTSE Russell 2015).
- 24.
Among the relatively few investment decisions that are exclusively the responsibility of ETF manager (not an index provider), the most significant seems to be the choice of the index replication method. Others are, for example, decisions on lending securities held by the fund and level of cash in the portfolio. They will be described later in this chapter.
- 25.
According to MSCI, “foreign room” is calculated as the proportion of shares still available to foreign investors relative to the maximum allowed. Similarly, FTSE Russell defines “foreign headroom” as the percentage of shares available to foreign investors as a proportion of the company’s FOL.
- 26.
Interestingly, MSCI removed and reduced the weights of two Chinese companies listed on the Shenzhen Stock Exchange (SZSE) from its China indexes in March 2019 when Chinese regulators blocked foreign purchases of their shares as offshore ownership of the firms neared the 30% cap (Reuters 2019).
- 27.
For example, in September 2013 Vodafone, which has had a primary listing on the London Stock Exchange (LSE), announced that it would sell its 45% stake in Verizon Wireless to US-listed Verizon Communications, in return for cash and Verizon Communications shares, which it would distribute to its own shareholders. This corporate event required different treatment in different FTSE Russell indexes (FTSE Russell 2015).
- 28.
In practice, some entities analyzing the ETF market sometimes distinguish also hybrid replication. Hybrid ETFs, launched in 2010, are structures that combine both replication techniques purely as a means to mitigate their downsides or special events such as the occasional impact of market closings (i.e., long public holiday periods in certain jurisdictions) or the temporary unavailability of certain securities (IOSCO 2013).
- 29.
In this book, as well as in many professional ETF publications, the shorthand term “index replication” is often used. However, it does not mean that it refers to mimicking the index composition, rather tracking its return (only in the case of full physical replication does it usually mean the same).
- 30.
It is noteworthy (also in the context of the synthetic replication in which counterparty risk occurs) that the portfolio securities of physical ETFs are held in a segregated custody account; therefore, the investor has direct recourse to those assets in the event that the fund sponsor fails.
- 31.
Preferred stocks (securities) are hybrid instruments that exhibit the characteristics of both equity and debt securities. The main issuers of these securities are banks and other financial institutions because they can help satisfy regulatory requirements to support their liabilities (it is reflected in major indexes comprising preferred stocks—e.g., more than 80% of the sector composition of the S&P US Preferred Stock Index is about financials and real estate [Dhanraj 2018]). ETFs investing in preferred stocks are popular, especially in the USA—total assets managed by 12 US-listed funds amounted to nearly USD 30 bn in mid-2019 (ETFdb.com 2019).
- 32.
There are three different levels of ADR programs which differ mainly in terms of listing exposure and reporting requirements: Level 1 (ADRs can only be traded on the OTC market, and the issuing company has minimal reporting requirements with the SEC), Level 2 (ADRs can be listed on a US stock exchange, but they must be registered with the SEC, and the company is required to file an annual financial report that conforms to US GAAP standards), and Level 3 (it requires the issuing company to meet even stricter reporting rules that are similar to those followed by US companies, but companies can issue shares to raise capital rather than just list existing shares on a US exchange).
- 33.
However, depending on the level of the ADR program, investors may not have access to all the information available on domestic companies.
- 34.
ETF-JDRs are issued by a trust bank. They are backed by ETFs bought by a securities house on the foreign stock exchange.
- 35.
Tracking error is a measure of how consistently a fund is tracking its benchmark.
- 36.
Tracking difference measures the under- or outperformance of a fund relative to its benchmark.
- 37.
In the latter case, full replication can be used provided that the index itself is adapted to the legal requirements concerning portfolio diversification in force in a given country—as a rule capped indexes are created (they will be described later in the book).
- 38.
Such numerous indexes are over-diversified, which—as shown by many studies—is costly and does not give significant advantages in terms of lower firm-specific (idiosyncratic) risk. Most researchers indicate that an optimally diversified investment portfolio should cover approximately 20–40 securities; only a few show that it should be even more than 100 (e.g., Meir Statman (2004) claims that it should be at least 300 stocks). Although the issue of the optimum level of diversification has been extensively debated in the financial literature for over 50 years (the first paper devoted to this topic was authored by Evans and Archer [1968]), the definitive answer to that question remains elusive.
- 39.
In practice, optimized sampling is also used, which combines both methods.
- 40.
It should be noted that, regardless of the replication method used, almost all index-tracking ETFs benefit from a liquidity screen in the index methodology, which serves to avoid highly illiquid assets. The problem of asset liquidity in the fund’s portfolio, however, is important for the investor not only with regard to the quality of index replication, but also—and perhaps even more so—in the event of liquidity mismatch. This emerges when liquid ETFs hold relatively illiquid securities, and although they offer daily dealing, they are unable to meet that promise because of the hard-to-sell nature of their underlying holdings. Additionally, liquidity mismatch can reduce market efficiency and increase the fragility of ETFs (Pan and Zeng 2017).
- 41.
According to Deutsche Bundesbank (2018), representative sampling is dominant method of replication in the USA—in 2018 it has been using by ca. 1600 ETFs. In Europe it is applied by ca. 600 ETFs.
- 42.
- 43.
Overfitting is the modeling error which can happen when a function is too closely fit to a limited set of data points. It occurs when a model describes noise rather than signal and, as a result, it finds patterns that aren’t actually there. An illustration of the problems created by overfitting (and collinearity) in the case of ETFs was described in, e.g., Lee (2014).
- 44.
For example, the MSCI ACWI Small Cap Index has 6002 constituents, the S&P Global SmallCap Index has 8330 constituents and the FTSE Global Small Cap Index has 4972 constituents (as of 31 July 2019). More on global passive equity investing in small-caps can be found in Chapter 4.
- 45.
In the European Union, the use of efficient portfolio management techniques (EPM) by UCITS funds (including ETFs) is regulated by ESMA guidelines (ESMA 2014). A number of various activities fall under EPM, including securities lending, engaging in (reverse) repurchase agreements, and employing financial derivatives. UCITS funds are permitted to engage in EPM in order to reduce risk and costs, or generate additional capital or income. However, such an activity should be in line with the funds’ risk profiles and respect the rules laid down in ESMA’s guidelines.
- 46.
A swap is an agreement between two parties whereby they promise to exchange the return from a particular asset in lieu of actually transferring ownership. They are often non-standardized arrangements, tailored to the specific needs of the parties involved. The terms of the swap, such as what is actually being exchanged and for what time period, are set out in a contract usually based on a template that has been created by the International Swaps and Derivatives Association (ISDA) (Johnson et al. 2012a).
- 47.
A total return swap is a bilateral financial transaction where the counterparties swap the total return of a single asset or basket of assets for periodic cash flows, typically a floating rate such as LIBOR.
- 48.
- 49.
The analysis of the advantages and disadvantages of ETFs using synthetic replication is conducted from their providers’ and investors’ point of view. We have omitted the potential impact of these kinds of financial instruments on financial market stability on a global scale—which is the subject of many studies listed earlier—as well as the point of view of other entities (e.g., a bank operating as a swap counterpart).
- 50.
See, for example, Deutsche Bank (2010), Johnson et al. (2012b), Elia (2012), Dickson et al. (2013), and Meinhardt et al. (2015). Different results are presented in, e.g., Naumenko and Chystiakova (2015) and Mateus and Rahmani (2017). Similar tracking efficiency was observed by Maurer and Williams (2014).
- 51.
According to data collected by Vanguard (Dickson et al. 2013), emerging markets equity is the only asset class category in which synthetic ETFs has outstandingly higher share in European ETF market in comparison with physical ETFs (13% vs. 6%).
- 52.
Apart from ETFs with exposure to major asset classes, i.e., equity and fixed income, synthetic replication is widely employed—using oftentimes futures and option contracts—by leveraged, inverse, and leveraged inverse ETFs, as well as commodity ETFs and ETCs (exchange-traded commodities).
- 53.
It should be added that also investors in physical ETFs that lend securities are exposed to counterparty risk, which will be discussed later in this chapter.
- 54.
The number of synthetic ETFs amounts to 912 funds, which is about 32% of all European-domiciled ETFs (as at the end of June 2018). There are 1025 ETFs in total, including also derivative-based ETFs (36% of all European-domiciled ETFs) (Pagano et al. 2019).
- 55.
In November 2019, Securities and Exchange Commission proposed new regulations for the use of derivatives by investment funds, especially inverse and leveraged ETFs, to introduce some safeguards for more risky products and increase competition. New proposals are aimed to standardize the framework for funds’ derivatives risk management.
- 56.
The Commission Directive 2010/43/EU defines counterparty risk as “the risk of loss for the UCITS resulting from the fact that the counterparty to a transaction may default on its obligations prior to the final settlement of the transaction’s cash flow” (Commission Directive 2010/43/EU of 1 July 2010 implementing Directive 2009/65/EC of the European Parliament and of the Council as regards organizational requirements, conflicts of interest, conduct of business, risk management, and content of the agreement between a depositary and a management company—article 3, point 7).
- 57.
For instance, under Europe’s UCITS Directive, a fund’s exposure to counterparties may not exceed a total of 10% of its net asset value. This means that the daily NAV of the substitute basket should amount to at least 90% of the ETF’s NAV. For swap counterparties which are not credit institutions, this limit is reduced to 5%.
- 58.
- 59.
According to EMSA guidelines (2014), all collateral used to reduce counterparty risk exposure should comply with the following criteria: liquidity (any collateral other than cash should be highly liquid and traded on a regulated market or MTF with transparent pricing in order that it can be sold quickly at a price that is close to pre-sale valuation), valuation (collateral should be valued on at least a daily basis and assets that exhibit high price volatility should not be accepted as collateral unless suitably conservative haircuts are in place), high quality, independence and correlation (collateral should be issued by an entity that is independent from the counterparty and is expected not to display a high correlation with the performance of the counterparty) and diversification (collateral should be sufficiently diversified in terms of country, markets, and issuers).
- 60.
However, according to the research carried out by Pérignon et al. (2014) on a sample of 164 ETFs managed by Deutsche Bank (db x-trackers ETF) with a 40.9 billion USD collateral portfolio, there was a good fit between the asset exposure of the fund, e.g., equity or fixed income, and the collateral used to secure the swap. The match between exposure and collateral turned out to be lower for geographic exposures, especially in ETFs tracking Asia-Pacific or North-American indexes which might have been a consequence of home bias. Moreover, the correlation between the returns of the ETF and of its collateral was, on average, positive.
- 61.
Other types of conflicts of interest can occur also in other types of ETFs—they can reveal themselves wherever several ETF functions are located within one financial group. For example, this applies to a situation in which an ETF issuer is also involved in the design and/or calculation of the reference index, or it acts as a liquidity provider on the secondary market of the ETF (Financial Stability Board 2011).
- 62.
ESMA guidelines (2014) indicate that a UCITS fund’s prospectus should clearly inform investors of its collateral policy.
- 63.
The volume-weighted average fee is calculated by summing the value of each transaction (the loan value multiplied by the fee) and dividing it by the total loan value.
- 64.
Term “securities on loan” means the total amount of securities currently loaned out in the market. As of April 1, 2019, DataLend tracked approximately USD 2.3 trillion worth of securities on loan across the global securities finance market.
- 65.
Approximate values based on IHS Markit data from the last few quarters.
- 66.
Generally, ETFs may not lend more than one-third of total assets, but in calculating this limit, the SEC has taken the view that collateral may be included as part of the lending fund’s total assets. Thus, an ETF could lend up to 50% of its asset value before the securities loan. In practice, they do not use this limit, as shown in McCullough (2018).
- 67.
In the ESMA guidelines (ESMA 2014), any limits for the proportion of assets that may be subject to securities lending were not recommended. ESMA only indicated that a UCITS fund “should ensure that it is able at any time to recall any security that has been lent out or terminate any securities lending agreement into which it has entered.” Additionally, ESMA specified a number of requirements related to “efficient portfolio management techniques” which also include securities lending.
- 68.
The research sample covered almost 3000 observations from 2007 through the first half of 2018. It included 440 unique index mutual funds and ETFs from 10 fund sponsors.
- 69.
It included almost 200 ETFs engaged in securities lending, both equity and bond funds.
- 70.
The research was conducted in 2018 on a sample including 250 funds from the 10 largest US index fund and ETF sponsors.
- 71.
Better Finance, the European Federation of Investors and Financial Services Users, is the public interest, non-governmental organization advocating and defending the interests of European citizens as financial services users at the European level to lawmakers and the public in order to promote research, information, and training on investments, savings and personal finances.
- 72.
The research sample included 30 mainstream equity ETFs managed by the 10 biggest European ETF providers.
- 73.
According to Deloitte (2019), in 2019, withholding tax rates for dividends in some European countries reached 20% or even more—e.g., 27.5% in Austria, 20% in Finland, 30% in France, 25% in Germany, 25% in Portugal, and 35% in Switzerland.
- 74.
According to a Deutsche Bank study, almost two-thirds of the US ETF market at the end of 2018 was controlled by institutional investors (USD 2.1 trillion), representing a fourfold increase in institutional use over the past 5 years (ETF Stream 2019).
- 75.
The term “lendable assets” means the total gross inventory of a securities. As of April 1, 2019, DataLend tracked approximately USD 19.9 trillion in lendable assets across the global securities finance market.
- 76.
Turnover ratio is a measure of the fund’s trading activity. It is usually computed by taking the lesser of purchases or sales and dividing by the average monthly net assets. A low turnover figure (20–30%) would indicate a buy-and-hold strategy. High turnover (more than 100%) would indicate an investment strategy involving considerable buying and selling of securities (http://www.morningstar.com/InvGlossary/turnover_ratio.aspx).
- 77.
According to Morningstar data, the median turnover among cap-weighted passive ETFs and passive mutual funds in the USA over the three years through 2018 was, respectively, 17 and 19%, while among active ETFs and active mutual fund it was 55 and 48%, respectively (Johnson and Bryan 2019).
- 78.
According to ETFGI data (as of April 2019), the assets of ETFs and ETPs with emerging markets exposure amounted to USD 549 billion, which accounted for only 9.8% of their total assets.
- 79.
For instance, according to IHS Markit data, in mid-2019, the average value of lendable EM equities was significantly below USD 100 bn, while in the case of most developed European and Asian markets it was usually several hundred billion USD and in the case of US equities over 8.5 trn USD.
- 80.
Moreover, lending fees also depend on considerations unique to each transaction, including the nature, size, and duration of the transaction, the type of collateral offered, and the credit quality of the counterparty involved in the transaction.
- 81.
Own calculations based on BlackRock (2018).
- 82.
Funds with more than USD 5 billion in AUM and securities lending returns of at least 0.05% were analyzed.
- 83.
Own calculations based on BlackRock (2019).
References
Anadu, K. E., Kruttli, M., McCabe, P., Osambela, E., & Shin, C. H. (2018). The Shift from Active to Passive Investing: Potential Risks to Financial Stability? (Working Paper RPA 18-04). https://www.bostonfed.org/-/media/Documents/Workingpapers/PDF/2018/rpa1804.pdf. Accessed 25 July 2019.
Aramonte, S., Caglio, C., & Tuzun, T. (2017). Synthetic ETFs, FEDS Notes 2017-08-10, Board of Governors of the Federal Reserve System (U.S.). https://www.federalreserve.gov/econres/notes/feds-notes/synthetic-etfs-20170810.htm. Accessed 11 Aug 2019.
Atkinson, H. J., & Green, D. (2005). The New Investment Frontier III: A Guide to Exchange Traded Funds for Canadians. Toronto: Insomniac Press.
Baklanova, V., Copeland, A., & McCaughrin, R. (2015). Reference Guide to U.S. Repo and Securities Lending Markets (Federal Reserve Bank of New York Staff Reports, Staff Report No. 740). https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr740.pdf. Accessed 1 Sept 2019.
Beasley, J. E., Meade, N., & Chang, T.-J. (2003). A Evolutionary Heuristic for the Index Tracking Problem. European Journal of Operational Research, 148, 622–623.
Benedict, C. (2019). Amidst Global Trade Wars, the Securities Markets Response. The Purple, Issue 6, DataLend. https://datalend.com/amidst-global-trade-wars-the-securities-finance-market-responds/. Accessed 26 Aug 2019.
Better Finance. (2017). Better Finance Helps Investors Identify Potential Falsely Active Funds (“Closet Indexers”), and Asks Regulators to Investigate Further. https://betterfinance.eu/wp-content/uploads/publications/EN_-_Press_Release_and_Annexes_2_3_-_Better_Finance_replication_of_ESMA_study_on_Closet_Indexing.pdf. Accessed 20 June 2019.
Better Finance. (2019). Efficient Portfolio Management Techniques: Attribution of Profits Derived from Securities Lending by UCITS Exchange-Traded Funds. https://betterfinance.eu/wp-content/uploads/BETTER-FINANCE-Research-Paper-Securities-Lending-11062019.pdf. Accessed 30 Aug 2019.
Bhattacharya, A., & O’Hara, M. (2020). ETFs and Systemic Risks. https://www.cfainstitute.org/-/media/documents/article/rf-brief/etfs-and-systemic-risks.ashx. Accessed 2 Feb 2020.
Bioy, H., Garcia-Zarate, J., Lamont, K., Boyadzhiev, D., & Kang, H. (2019). A Guided Tour of the European ETF Marketplace. https://www.morningstar.com/lp/guided-tour-european-etf-marketplace. Accessed 24 July 2019.
Bioy, H., & Rose, G. (2012). Securities Lending in Physical Replication ETFs: A Review of Providers’ Practices, Morningstar ETF Research. https://media.morningstar.com/uk/media/ETF/SecuritiesLendinginPhysicalETFs.pdf. Accessed 22 Aug 2019.
BlackRock. (2010). Overview of ETF Structures: How ETFs Track Their Benchmark.
BlackRock. (2011). ETF Landscape: Industry Review. End H1 2011. New York: BlackRock Investment Institute.
BlackRock. (2012). ETP Due Diligence: A Framework to Help Investors Select the Right European Exchange Traded Products (ETPs). https://www.altii.de/media/modelfield_files/dokumente/dokument/datei/etp-due-diligence–report-en-emea-pc-whitepaper.pdf. Accessed 18 Aug 2019.
BlackRock. (2018). iShares Securities Lending: Unlocking the Potential of Portfolios. https://www.ishares.com/uk/professional/en/literature/brochure/ishares-securities-lending-en-emea-pc.pdf. Accessed 6 May 2019.
BlackRock. (2019). iShares Securities Lending: Unlocking the Potential of Portfolios. https://www.ishares.com/us/literature/brochure/securities-lending-unlocking-portfolios-en-us.pdf. Accessed 2 Sept 2019.
Bloomberg. (2019). MSCI Urges China Ease Ownership Limits After Dropping Stock. https://www.bloomberg.com/news/articles/2019-03-07/msci-drops-foreign-favorite-from-china-gauges-on-access-concern. Accessed 24 June 2019.
CESR. (2010). CESR’s Guidelines on Risk Measurement and the Calculation of Global Exposure and Counterparty Risk for UCITS (CESR/10-788). https://www.esma.europa.eu/sites/default/files/library/2015/11/10_788.pdf. Accessed 12 Aug 2019.
Citibank. (2012). Securities Lending in the Emerging Markets. https://citi.com/mss/docs/09_12_securities_lending_emerging_markets.pdf. Accessed 2 Sept 2019.
Cunningham, M. (2017). The Australian Exchange-Traded Funds Market. https://www.rba.gov.au/publications/bulletin/2017/jun/pdf/bu-0617-6-the-australian-exchange-traded-funds-market.pdf. Accessed 16 Aug 2019.
DataLend. (2019). Securities Finance Industry Generated $9.96 Billion in Revenue in 2018. https://datalend.com/securities-finance-industry-generated-9-96-billion-in-revenue-in-2018/. Accessed 26 Aug 2019.
Deloitte. (2019). Withholding Tax Rates 2019. https://www2.deloitte.com/content/dam/Deloitte/global/Documents/Tax/dttl-tax-withholding-tax-rates.pdf. Accessed 30 Aug 2019.
Deutsche Bank. (2010). Do ETFs Trackers Track? European Equity ETF Tracking Error Under the Microscope. Deutsche Bank Global Equity Index & ETF Research.
Deutsche Bank. (2012). db X-Trackers ETFs Under the Microscope: A Guide to ETF Structures and Risks, with an In-Depth Look at db X-Trackers ETFs. https://www.wertpapier-forum.de/applications/core/interface/file/attachment.php?id=86190. Accessed 1 Aug 2019.
Deutsche Bundesbank. (2018, October). The Growing Importance of Exchange Traded Funds in the Financial Markets (Monthly Report). https://www.bundesbank.de/resource/blob/766600/2fd3ae4f0593fb2ce465c092ce40888b/mL/2018-10-exchange-traded-funds-data.pdf. Accessed 27 July 2019.
Dhanraj, C. (2018). Potential Benefits and Risks of Preferred Stocks. https://www.ishares.com/us/insights/potential-benefits-and-risks-of-preferred-stocks. Accessed 22 July 2019.
Dickson, J. M., Mance, L., & Rowley, J. J., Jr. (2013). Understanding Synthetic ETFs. Vanguard. https://www.vanguard.com.hk/documents/understand-synthetic-etfs-tlrv.pdf. Accessed 11 Aug 2019.
Elia, M. (2012). Tracking Error of Traditional and Synthetic European Exchange-Traded Funds (Working Paper). University of Turin. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2003976. Accessed 13 Aug 2019.
ESMA. (2011). ESMA’s Policy Orientations and Guidelines for UCITS Exchange Traded Funds and Structured UCITS, ESMA/2011/220. https://www.esma.europa.eu/sites/default/files/library/2015/11/2011_220.pdf. Accessed 24 July 2019.
ESMA. (2014). Guidelines for Competent Authorities and UCITS Management Companies. Guidelines on ETFs and Other UCITS Issues, ESMA/2014/937EN. https://www.esma.europa.eu/sites/default/files/library/2015/11/esma-2014-0011-01-00_en_0.pdf. Accessed 4 Aug 2019.
ESMA. (2016). Supervisory Work on Potential Closet Index Tracking, ESMA/2016/165. https://www.esma.europa.eu/sites/default/files/library/2016-165_public_statement_-_supervisory_work_on_potential_closet_index_tracking.pdf. Accessed 20 June 2019.
ETF Stream. (2019). How Institutional Investors Are Using ETFs. https://www.etfstream.com/news/7680_how-institutional-investors-are-using-etfs/. Accessed 1 Sept 2019.
ETFdb.com. (2019). Preferred Stock ETF List. https://etfdb.com/etfs/asset-class/preferred-stock/. Accessed 22 July 2019.
ETFGI. (2019). ETFGI Reports That Assets Invested in Actively Managed ETFs/ETPs Reached a New Record High of US$151.24 Billion at the End of November 2019. https://etfgi.com/news/press-releases/2019/12/etfgi-reports-assets-invested-actively-managed-etfsetps-reached-new. Accessed 3 Jan 2020.
European Systemic Risk Board. (2011). ESRB Response to the ESMA Discussion Paper on “Policy Orientations and Guidelines for UCITS Exchange-Traded Funds and Structured UCITS”. https://www.esrb.europa.eu/pub/pdf/other/ESRB_response_to_ESMA_consultation_exchange_traded_funds.pdf?19949ead0d7d404b93ae1dcd57ed9d2b. Accessed 24 July 2019.
Evans, J. L., & Archer, S. H. (1968). Diversification and the Reduction of Dispersion: An Empirical Analysis. Journal of Finance, 23(5), 761–767.
Fang, K., & Heinrichs, J. (2017). Understanding the Regulation of Exchange-Traded Funds Under the Securities Exchange Act of 1934. Investment Company Institute. https://www.ici.org/pdf/ppr_17_etf_listing_standards.pdf. Accessed 13 June 2019.
Ferri, R. A. (2009). The ETF Book: All You Need to Know About Exchange-Traded Funds. Hoboken: Wiley.
Ferri, R. A. (2011). The Power of Passive Investing: More Wealth with Less Work. Hoboken: Wiley.
Financial Stability Board. (2011). Potential Financial Stability Issues Arising from Recent Trends in Exchange-Traded Funds (ETFs). https://www.fsb.org/wp-content/uploads/r_110412b.pdf. Accessed 24 July 2019.
FTSE Russell. (2015). How Indexes Change. https://content.ftserussell.com/sites/default/files/research/how_indexes_change_final.pdf. Accessed 22 June 2019.
Fuhr, D. (2014). Depositary Receipt Structures Open ETF Horizons. https://www.fnlondon.com/articles/depositary-receipt-structures-open-etf-horizons-20141020. Accessed 24 July 2019.
Gastineau, G. L. (2010). The Exchange-Traded Funds Manual (2nd ed.). Hoboken: Wiley.
Grill, M., Lambert, C., Marquardt, P., Watfe, G., & Weistroffer, C. (2018, November). Counterparty and Liquidity Risks in Exchange-Traded Funds (Financial Stability Review). https://www.ecb.europa.eu/pub/financial-stability/fsr/special/html/ecb.fsrart201811_3.en.html. Accessed 25 July 2019.
Hill, J. M., Nadig, D., & Hougan, M. (2015). A Comprehensive Guide to Exchange-Traded Funds (ETFs). Charlottesville: CFA Institute Research Foundation.
Hurlin, C., Iseli, G., Pérignon, C., & Yeung, S. (2019). The Counterparty Risk Exposure of ETF Investors. Journal of Banking & Finance, 102(May), 215–230.
IHS Markit. (2019). Securities Finance Quarterly Review. Q2 2019. https://cdn.ihs.com/www/pdf/0719/SecuritiesFinanceQ2Review.pdf. Accessed 28 Aug 2019.
International Monetary Fund. (2011). Global Financial Stability Report: Durable Financial Stability: Getting There From Here. https://www.imf.org/~/media/Websites/IMF/imported-flagship-issues/external/pubs/ft/GFSR/2011/01/pdf/_textpdf.ashx. Accessed 24 July 2019.
International Monetary Fund. (2015). Global Financial Stability Report: Navigating Monetary Policy Challenges and Managing Risks. https://www.elibrary.imf.org/doc/IMF082/22119-9781498372930/22119-9781498372930/Other_formats/Source_PDF/22119-9781475596588.pdf. Accessed 25 July 2019.
Investment Company Institute. (2019). Investment Company Fact Book 2019: A Review of Trends and Activities in the Investment Company Industry. https://www.ici.org/pdf/2019_factbook.pdf. Accessed 16 June 2019.
Investment Industry Association of Canada. (2019). IIAC Market Insights—Canadian ETF Dynamics, Risks and Outlook. https://iiac.ca/wp-content/uploads/Canadian-ETF-Market-Jan2019.pdf. Accessed 24 July 2019.
IOSCO. (2012). Principles for the Regulation of Exchange Traded Funds (Consultation Report). http://www.iosco.org/library/pubdocs/pdf/IOSCOPD376.pdf. Accessed 24 July 2019.
IOSCO. (2013). Principles for the Regulation of Exchange Traded Funds (Final Report). https://www.iosco.org/library/pubdocs/pdf/IOSCOPD414.pdf. Accessed 30 June 2019.
Jagannathan, R., Farnsworth, G., Bushonville, A., & Puma, G. (2015). Index Replication: Principles and Applications. DSC Quantitative Group. https://www.dscqg.com/wp-content/uploads/2018/04/IndexReplication.pdf. Accessed 2 August 2019.
Johnson, B., Bioy, H., Garcia-Zarate, J., Choy, J., Gabriel, J., Rose, G., & Kellett, A. (2012a, May). Synthetic ETFs Under the Microscope: A Global Study, Morningstar ETF Research. http://media.morningstar.com/eu/ETF/assets/SyntheticETFsUnderTheMicroscope_AGlobalStudy_Morningstar.pdf. Accessed 10 Aug 2019.
Johnson, B., Bioy, H., Kellett, A., & Davidson, L. (2012b). On the Right Track: Measuring Tracking Efficiency in ETFs, Morningstar ETF Research. https://media.morningstar.com/uk/MEDIA/Research_Paper/Morningstar_Report_Measuring_Tracking_Efficiency_in_ETFs_February_2013.pdf. Accessed 13 Aug 2019.
Johnson, B., & Bryan, A. (2019). Measuring ETFs’ Tax Efficiency Versus Mutual Funds, Morningstar Manager Research. https://www.morningstar.com/lp/etf-tax-efficiency. Accessed 1 Sept 2019.
JPMorgan. (2009). Optimization vs. Full Replication, ETF Quarterly 3Q 2009. https://www.jpmorgan.com/tss/DocumentForEmail/ETF_Quarterly_3Q09_Optimization_vs_Full_Replication/1253320931154. Accessed 28 July 2019.
JPMorgan Chase. (2005). JPMorgan Depositary Receipt Guide. http://quantlabs.net/academy/download/free_quant_instituitional_books_/%5BJP%20Morgan%5D%20Depositary%20Receipts%20Reference%20Guide.pdf. Accessed 22 July 2019.
Kilbert, M., & Subramanian, R. A. (2010). Revisiting Global Small Caps, MSCI Index Research Group. https://www.msci.com/documents/10199/3378e77e-556f-4c6a-8b47-421149cc3f4d. Accessed 1 Aug 2019.
Kupiec, P. H. (1990). A Survey of Exchange-Traded Basket Instruments. Journal of Financial Services Research, 4, 175–190.
Lamont, K. (2015). How Foreign Ownership Rules Impact Passive Funds. http://www.morningstar.co.uk/uk/news/141049/how-foreign-ownership-rules-impact-passive-funds.aspx. Accessed 24 June 2019.
Lee, S. (2014). An Aggressive Quality and Value Dividend Fund. https://www.morningstar.com/articles/665373/an-aggressive-quality-and-value-dividend-fund Accessed 1 Aug 2019.
Liu, S., Sheikh, A., & Stefek, D. (2001). Optimal Indexing. In A. S. Neuberg (Ed.), Indexing for Maximum Investment Results. London: Routledge.
Lyxor. (2019). Guide to Pragmatic Replication. https://www.lyxoretf.co.uk/pdfDocuments/Lyxor_Pragmatic%20replication%20guide.pdf. Accessed 11 Aug 2019.
Maeda, K., & Shino, J. (2019). Stock Lending Market and the BOJ’s ETF Purchasing Program: Micro-Evidence from ETF Balance Sheet Data and Equity Repo Trading Data (WINPEC Working Paper Series No. E1811). https://www.waseda.jp/fpse/winpec/assets/uploads/2019/01/No.E1811.pdf. Accessed 29 Aug 2019.
Mateus, C., & Rahmani, Y. (2017). Physical Versus Synthetic Exchange Traded Funds. Which One Replicates Better? Journal of Mathematical Finance, 7(4), 975–989.
Maurer, F., & Williams, S. O. (2014). Physically Versus Synthetically Replicated Trackers: Is There a Difference in Terms of Risk? Journal of Applied Business Research, 31(1), 131–146.
McCullough, A. (2018). Securities Lending: An Examination of the Risks and Rewards. Morningstar. https://www.morningstar.com/lp/securities-lending-risks-rewards. Accessed 22 Aug 2019.
McLeavey, D., & Solnik, B. (2009). International Investments. Boston: Pearson Prentice Hall.
Meinhardt, C., Mueller, S., & Schoene, S. (2015). Physical and Synthetic Exchange Traded Funds: The Good, the Bad or the Ugly. The Journal of Investing, Summer, 24(2), 35–44.
Naumenko, K., & Chystiakova, O. (2015). An Empirical Study on the Differences Between Synthetic and Physical ETFs. International Journal of Economics and Finance, 7(3), 24–35.
Olma, A. (2001). Implementing Equity Index Portfolios. In A. S. Neuberg (Ed.), Indexing for Maximum Investment Results. London: Routledge.
Osaki, S. (2001). The Development of Exchange-Traded Funds (ETFs) in Japan. Capital Research Journal, 4(3), 45–51.
Pagano, M., Sanchez Serrano, A., & Zechner, J. (2019, June). Can ETFs Contribute to Systemic Risk? (ESRB Reports of the Advisory Scientific Committee No 9). https://www.esrb.europa.eu/pub/pdf/asc/esrb.asc190617_9_canetfscontributesystemicrisk~983ea11870.en.pdf. Accessed 25 July 2019.
Pan, K., & Zeng, Y. (2017, December). ETF Arbitrage Under Liquidity Mismatch (European Systemic Risk Board Working Papers Series, No. 59). https://www.esrb.europa.eu/pub/pdf/wp/esrb.wp59.en.pdf?c32ad640616557344d67f09d62590646. Accessed 30 July 2019.
Pérignon, C., Yeung, S., Hurlin, C., & Iseli, G. (2014). The Collateral Risk of ETFs (HEC Research Papers Series 1050). https://ideas.repec.org/p/ebg/heccah/1050.html. Accessed 18 Aug 2019.
Pierson, S. (2018). Rising High, Securities Lending Times, No. 204. http://www.securitieslendingtimes.com/sltimes/SLT_issue_204.pdf. Accessed 2 Sept 2019.
PricewaterhouseCoopers. (2004). Entering the United States Securities Markets: A Guide for Non-U.S. Companies. https://www.pwc.pl/en/rynki-kapitalowe/enteringtheus.pdf. Accessed 23 July 2019.
PricewaterhouseCoopers. (2019, September). European ETF Listing and Distribution. https://www.pwc.lu/en/asset-management/etfs/etf-poster-2019.html. Accessed 26 Sept 2019.
Ramaswamy, S. (2011). Market Structures and Systemic Risks of Exchange-Traded Funds (Bank for International Settlements Working Papers, No 343). https://www.bis.org/publ/work343.pdf. Accessed 24 July 2019.
Reuters. (2019). MSCI Deletes Shenzhen Stock from Indexes Due to Foreign Ownership Limits. https://www.reuters.com/article/china-stocks-msci/update-2-msci-deletes-shenzhen-stock-from-indexes-due-to-foreign-ownership-limits-idUSL3N20U1BP. Accessed 24 June 2019.
Rey, D. M., & Seiler, D. (2001). Indexation and Tracking Errors (Working Paper, No. 2). University of Basel/University of St. Gallen.
SCM Direct. (2015). Closet Indexation. The UK Epidemic Continues. https://scmdirect.com/wp-content/uploads/2019/06/Closet-Indexation-Epidemic-Continues-Report-February-2015-SCM-Direct.pdf. Accessed 20 June 2019.
Seddik Meziani, A. (2006). Exchange-Traded Funds as an Investment Option. Hampshire: Palgrave Macmillan.
Seddik Meziani, A. (2016). Exchange-Traded Funds: Investment Practices and Tactical Approaches. London: Palgrave Macmillan.
SET. (2018). SET Lists First Depositary Receipt Representing Overseas ETF on December 18. https://www.set.or.th/set/newsdetails.do?newsId=15446582077540&sequence=0&language=en&country=US. Accessed 24 July 2019.
SFC. (2018). Research Paper on Hong Kong ETF Market and Topical Issues in the ETF Space. https://www.sfc.hk/web/EN/files/PCIP/Research/Research%20Paper_20180116.pdf. Accessed 16 Aug 2019.
Statman, M. (2004). The Diversification Puzzle. Financial Analyst Journal, 60(4), 44–53.
Stevenson, D. (2010). The Financial Times Guide to Exchange Traded Funds and Index Funds: How to Use Tracker Funds in Your Investment Portfolio. Pearson Education: Harlow.
Sushko, V., & Turner, G. (2018, March). The Implications of Passive Investing for Securities Markets. BIS Quarterly Review. https://www.bis.org/publ/qtrpdf/r_qt1803j.pdf. Accessed 25 July 2019.
The Business Times. (2019). First Abu Dhabi Bank Proposes to Remove Foreign Ownership Limit. https://www.businesstimes.com.sg/banking-finance/first-abu-dhabi-bank-proposes-to-remove-foreign-ownership-limit. Accessed 24 June 2019.
The Economist. (2017, August 24). Private-Equity Returns Can Be Replicated with Public Shares. https://www.economist.com/finance-and-economics/2017/08/24/private-equity-returns-can-be-replicated-with-public-shares. Accessed 2 Aug 2019.
Vanguard. (2015). ETF Structures At-a-Glance. https://advisors.vanguard.com/iwe/pdf/FASTR.pdf?cbdForceDomain=true. Accessed 4 Feb 2016.
Vanguard. (2016). Exchange-Traded Funds: Clarity Amid the Clutter. https://www.vanguardinvestments.se/documents/etfs-clarity-amid-clutter.pdf. Accessed 14 June 2019.
Vanguard. (2019). Exchange-Traded Funds: Clarity Amid the Clutter. https://personal.vanguard.com/pdf/ISGETFC.pdf. Accessed 14 June 2019.
Vanguard Mexico. (2019). How Are ETFs Regulated? https://www.vanguardmexico.com/institutional/en/etf-knowledge-basics/how-are-etfs-regulated-tab. Accessed 17 June 2019.
Wiandt, J., & McClatchy, W. (2002). Exchange Traded Funds. New York: Wiley.
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
Copyright information
© 2020 The Author(s)
About this chapter
Cite this chapter
Miziołek, T., Feder-Sempach, E., Zaremba, A. (2020). The Basics of Exchange-Traded Funds. In: International Equity Exchange-Traded Funds. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-53864-4_3
Download citation
DOI: https://doi.org/10.1007/978-3-030-53864-4_3
Published:
Publisher Name: Palgrave Macmillan, Cham
Print ISBN: 978-3-030-53863-7
Online ISBN: 978-3-030-53864-4
eBook Packages: Economics and FinanceEconomics and Finance (R0)