Exchange Traded Funds: A Concise Guide to ETFs.
Francis Groves, Harriman House, 207 pages, £20.99 from the publisher (RRP £34.99).
This is another of Harriman House?s admirably clear guides for investors, written in this case by a financial editor on the latest generation of collective investments ? exchange traded index trackers.
The first part of the book describes how ETFs work and puts their development into historic context. Their rapid growth (now over $1,000 billion worldwide) reflects their efficient tracking of indices, their liquidity and their low cost ? and their significant tax advantages in the US. Whilst positioned as building blocks for ?buy and hold? portfolios, in practice most ETFs are held by professional investors and are actively traded, which makes them attractive to the providers. How ETFs work is important - in the US they generally involve full in kind replication (share backing in the case of equity ETFs) but in Europe they mostly involve ?swap based? synthetic replication, ultimately relying on the sponsor?s parent bank to guarantee performance ?introducing counterparty risk and not allowed in the US.
The second part of the book describes the wide range of ETFs available, ETCs (Exchange Traded Commodities) and some of the advanced ETFs ? where the daily tracking used in leveraged and short ETFs can led to perverse effects when compounded. The last section deals with the practicalities of using ETFs, including the many points that need researching and where prospectuses and fact sheets are often unhelpfully written - including topics such as tax (get it wrong and you can end up paying income tax on capital gains, or suffering withholding tax), regulatory and compensation status (many UK traded ETFs are domiciled and regulated elsewhere), and dividend and currency status.
The book is directed at professional investors and financial advisers rather than the private investor, but the private investor will find it useful in pointing to the complexities and pitfalls behind what appear at first sight to be simple instruments for tracking investment themes.
Jeremy Prescott, March 2011