An Exchange Traded Fund (ETF) is a security that tracks an index, a commodity or a basket of assets like an open-end investment fund, but trades on an exchange like a stock. ETFs have the combined characteristics of an open-end fund and a stock. Since ETFs are bought and sold on an exchange like shares, they are traded during trading hour.
With a single trade, you can buy and own a basket of securities, which can include an entire market, country or region.
ETFs are listed on an exchange. This allows you to easily access important information about the funds including their real-time prices, trading volumes and index composition.
You can buy and sell ETFs at any time during the trading day.
The management fee of an ETF is typically lower than that of a unit trust.
An authorised index tracking exchange traded fund (ETF) is a fund authorised by the Securities and Futures Commission (SFC) that is traded on an exchange. Its principal objective is to track, replicate or correspond to the performance of an underlying index. The index can be on a stock market, a specific segment of a stock market or a group of stock markets in a region or elsewhere in the world. It can also be on bonds or commodities.
An ETF gives investors an indirect access to a certain market. By investing in an ETF, investors can receive a return that replicates (although not 100% in most cases) the performance of the index without actually owning the constituents that comprise the index. In some cases, an ETF tracks an index of a market that has restricted access (such as, the China A-share market and the Indian market), thus giving investors indirect access to a market that is not accessible by foreign investors not domiciled in that jurisdiction.
ETFs are passively managed funds which aim to track closely the performance of the underlying benchmarks.
Each ETF has its own website operated by its ETF manager (a list of ETFs' websites can be found on the HKEx website). ETFs' websites provide key information such as the underlying benchmarks and the benchmarks' constituents, the ETF's Net Asset Value (NAV), the counterparty exposure and details of collateral from counterparties. The NAV of an ETF is the sum of marked-to-market values of the individual portfolio holdings plus the portion of the assets held in cash and cash equivalents, less all the accrued ETF expenses. The NAVs of ETFs are calculated intra-day during the trading hours and at the end of the trading day. The intra-day estimated NAVs, or iNAVs, are also known as RUPVs (Reference Underlying Portfolio Value) or IOPVs (Indicative Optimised Portfolio Value). The end-of-day NAV information may also be obtained on the HKEx news website, in addition to the ETF's website. Real-time or delayed price quotes for ETFs are disseminated by information vendors and are available on the HKEx website.
Unlike unlisted funds, ETFs do not charge any subscription fees. The transaction costs for trading ETFs at HKEx are the same as those for trading other securities, which include brokerage commission, transaction levy, investor compensation levy (currently suspended), trading fee, trading tariff and stamp duty (Some ETFs are exempted from stamp duty).
ETFs are traded in board lots and the minimum initial investment is usually set at an affordable level.
ETFs can be traded any time during the trading hours of the securities market. Listed ETFs usually have market makers, which are known as Securities Market Makers, to provide some liquidity. However, market making for the ETFs is available only during the Continuous Trading Session. The list of market makers for each ETF as well as their contact details are published on the HKEx website.
ETFs are traded through brokers in the same way as other securities and the settlement arrangements are the same.
Most ETFs track a portfolio of assets to provide diversified exposure to selected market themes. However, ETFs may also track a single underlying asset such as gold.
While some ETFs provide Hong Kong investors access to a basket of Hong Kong securities, others provide the investors access to overseas markets or other asset classes.
It is available for Professional Investor or Non- Professional Investor.
An ETF is exposed to the economic, political, currency, legal and other risks of a specific sector or market related to the index and the market that it is tracking.
ETF is not "actively managed" and therefore, when there is a decline in the underlying index, the ETF that tracks the index will also decrease in value. The ETF Manager will not take defensive positions in declining markets, investors may lose a significant part of their respective investments if the underlying Index falls.
Synthetic ETFs typically invest in over-the-counter derivatives issued by counterparties to track an index's performance. Such a synthetic ETF may suffer losses potentially equal to the full value of the derivatives issued by the counterparty upon its default.
Synthetic ETFs are therefore exposed to both the risks of the securities that constitute the index as well as the credit risk of the counterparty that issues the financial derivative instruments for replicating the performance of the index.
Some synthetic ETFs invest in financial derivatives issued by a number of different counterparties in order to diversify the counterparty credit risk concentration. However, the more counterparties an ETF has, the higher the mathematical probability of the ETF being affected by a counterparty default. If any one of the counterparties fails, the ETF may suffer losses.
You should also be aware that the issuers of these derivatives are predominantly international financial institutions and this, in itself, may pose a concentration risk.
For example, if a crisis strikes, affecting the financial sector, it is possible that the failure of one derivative counterparty of an ETF has a "knock-on" effect on other derivative counterparties of the ETF. As a result, an ETF could suffer a loss substantially more than its expected exposure in the event of a single counterparty default.
Some synthetic ETF managers, however, only acquire financial derivatives from one or a few counterparties. These managers may seek to reduce an ETF's net exposure to each single counterparty by requiring the counterparty(ies) to provide at least 100% collateralization to ensure there is no uncollateralized counterparty risk exposure arising from the use of financial derivatives to replicate index performance.
Investors should note in case where collateral is provided by counterparties to a synthetic ETF, the collateral may concentrate on particular market(s), sector(s) and/ or securities issued by specific sovereign or public issuer(s) which may not be related to the underlying index.
Furthermore, even if a synthetic ETF is fully collaterised, when the ETF seeks to exercise its right against the collateral, the market value of the collateral could be substantially less than the amount secured if the market dropped sharply before the collateral is realised, thereby resulting in significant loss to the ETF. Therefore, the relevant synthetic ETF managers have also been required to put in place a prudent haircut policy, in particular, where the collateral taken is in the form of equity securities, the market value of such equity collateral must be equivalent to at least 120% of the related gross counterparty risk exposure.
This refers to the disparity between the performance of the ETF (as measured by its NAV) and the performance of the underlying index. Tracking error may arise due to various factors. These include, failure of the ETF's tracking strategy, the impact of fees and expenses, foreign exchange differences between the base currency or trading currency of an ETF and the currencies of the underlying investments, or corporate actions such as rights and bonus issues by the issuers of the ETF's underlying securities.
Depending on its particular strategy, an ETF may not hold all the constituent securities of an underlying index in the same weightings as the constituent securities of the index. Therefore, the performance of the securities underlying the ETF as measured by its NAV may outperform or under-perform the index.
Since the trading price of an ETF is typically determined by the supply and demand of the market, the ETF may trade at a price higher or lower than its NAV. Also, here the reference index or market that an ETF tracks has restricted access, units in the ETF may not be created or redeemed freely and efficiently.
The supply and demand imbalance can only be addressed by creating and redeeming additional units. So, disruption to the creation or redemption of units may result in the ETF trading at a higher premium or discount to its NAV than may normally be the case for a traditional ETF with no such restriction.
In the event the ETF is terminated, investors may not be able to recover their investments.
An ETF, like any fund, may be terminated early under certain circumstances, for example, where the index is no longer available for benchmarking or if the size of the ETF falls below a pre-determined NAV threshold as set out in the constitutive documents and offering documents. Investors should refer to the section in the offering document relating to termination for further details.
Investors should also note that the market-making activities and the trading of ETF units may be adversely affected in the secondary market as the creation of units will cease once the termination of the ETF is announced. As a result, the trading price of such ETF units may become very volatile resulting in substantial losses to investors.
Furthermore, the NAV of an ETF may drop substantially once the expenses and costs of the termination is set aside upon announcement of the termination. Investors may suffer a substantial loss as a result of these expenses and costs associated with the termination.
For ETF that has provided for any potential tax liabilities, an investor may not be able to get any refund or further distribution from the tax provision upon termination of the ETF.
Listing or trading on the SEHK does not in and of itself guarantee that a liquid market exists for an ETF. Besides, a higher liquidity risk is involved if an ETF uses financial derivative instruments, including structured notes and swaps, which are not actively traded in the secondary market and whose price transparency is not as easily accessible as physical securities. This may result in a bigger bid and offer spread. These financial derivative instruments also are susceptible to more price fluctuations and higher volatility. Hence, they can be more difficult and costly to unwind early, especially when the instruments provide access to a restricted market where liquidity is limited in the first place.
Synthetic ETFs typically invest in derivatives to track an index's performance. The costs associated with the unwinding of these derivatives before maturity may vary depending on prevailing market conditions. Such costs may be significant, particularly during times of high market volatility.
Hence, in the event of redemption or if the synthetic ETF is terminated (for example, due to the reason that the fund size becomes too small), the proceeds payable to investors may be significantly less than the net asset value of the fund units as a result of the cost associated with unwinding of the derivatives before maturity. This may lead to substantial loss to investors.
Like all investments, an ETF may be subject to tax imposed by the local authorities in the market related to the index that it tracks, emerging market risks and risks in relation to the change of policy of the reference market.
The worst case is that you will lose the entire principal amount.
This product does not have a potential gain capture.
This product is not principal protected.
Risks Relating to ETF Termination
An ETF, like any fund, may be terminated early under certain circumstances, for example, where the index is no longer available for benchmarking or if the size of the ETF falls below a pre-determined NAV threshold as set out in the constitutive documents and offering documents. Investors should refer to the section in the offering document relating to termination for further details. Investors should also note that the market-making activities and the trading of ETF units may be adversely affected in the secondary market as the creation of units will cease once the termination of the ETF is announced. As a result, the trading price of such ETF units may become very volatile resulting in substantial losses to investors. Furthermore, the NAV of an ETF may drop substantially once the expenses and costs of the termination is set aside upon announcement of the termination. Investors may suffer a substantial loss as a result of these expenses and costs associated with the termination. For ETF that has provided for any potential tax liabilities, an investor may not be able to get any refund or further distribution from the tax provision upon termination of the ETF.
Early Unwinding of Derivatives Risk
Synthetic ETFs typically invest in derivatives to track an index's performance. The costs associated with the unwinding of these derivatives before maturity may vary depending on prevailing market conditions. Such costs may be significant, particularly during times of high market volatility. Hence, in the event of redemption or if the synthetic ETF is terminated (for example, due to the reason that the fund size becomes too small), the proceeds payable to investors may be significantly less than the net asset value of the fund units as a result of the cost associated with unwinding of the derivatives before maturity. This may lead to substantial loss to investors.
The product can be bought and sold via secondary market.
The product is a complex product and investors should exercise caution in relation to the product.
In the worst case scenario (e.g. insolvency of issuer), the investor may get nothing back and the potential maximum loss could be 100% of investment amount.
If the offering documents provided by the issuer have not been reviewed by the SFC; investors are advised to exercise caution in relation to the offer.
SFC authorization does not imply official recommendation or endorsement of a product nor does it guarantee the commercial merits of a product or its performance.
The product is available for professional investors / non- professional investors.
The above information is provided for reference only. The information may not contain all material terms, in and of itself should not form the basis for any investment decision. Potential investors must seek their own independent advice in relation to any legal, tax, accounting or regulatory issues relating to the matters discussed herein, By accepting receipt of this information the reader will be deemed to represent that they posses, either individually or through their advisor, sufficient investment expertise to understand the risks involved in any purchase or sale of any investment products, referenced herein, and investor has made its own independent judgment. The value, price or income from investments may fall as well as rise.