Basic considerations for

Implementing your IPS Investment Policy Statement with ETF portfolios

Disclaimers. This paper does not discuss how to choose a(n execution only) trading platform/ MTF Multilateral Trading Facility. This paper does not adress any particular ETF, does not fit for any particular portfolio of an investor and does not provide investment advice (under the MiFID regime).

ETFs Exchange Traded Funds are a securitization technique, no primary investment type or asset class and investing in ETFs itself does not replace knowledge about the underlying investments purchased by the fund and the fund's investment strategy
(Investment Policy). The fund prospectus provide you with this details. investment decisions, to be made based on the fund information, investment planning and investment advisory work, which shall constitute your Investment Policy Statement the required (basic/minimum) investment knowledge for DIY Do It Yourself investors (see end notes as well).

Checklist for choosing ETFs:

You find the concrete values for specific criteria of a particular fund in the publications of the fund/manager, the trading platform (bank, MTF) and the stock exchange where the ETF traded.

1. Passive Index ETF (non-active ETF /non actively managed, non-strategic, no niche ETF etc). This ensures a. that the investment vehicle able to meet requirements defined by your Investment Policy Statement, can b. c.
be mapped to given asset class(es) or in other words the portfolio-mix of the given target portfolio, the fund performance is genuinely measurable and verifiable by a well-known public index, so you need to know indices you consider for investing and benchmarking and the first step of the implementation is to pick your preferred indices from index families like FTSE, DAX, Eurostoxx, S&P, MSCI etc. based on their geographical (country, region), industry, currency, company size, maturity (bonds), etc. characteristics.

2. Full/physical replica or optimized Index ETF (abbrev. here FRI ETF; no swap, no ETN, no leverage, etc.). a. That means that the fund puts your money exactly in that securities and in such proportions which the b.
particular index of this ETF consists of. Optimized means the ETF holdings do not fully mirror the index for cost or other reasons, but in x% only. This needs further investigations again. If you dont buy a full replica index ETF, you just get a promise that the fund will pay off the index value, i. there is absolutely no guarantee that the fund actually invests your money in the particular titles represented by the index, ii. and you will bear the third party risks of the fund as well (e.g. swap counterparty), wich is limited to transaction and fraud risks in case of FRI ETFs, and may be an credit risk (if the fund does security lending, wich risk is again lower if guaranteed e.g. mortgage backed).

3. Total cost (TER Total Expense Ratio, the international measure of investment cost: the fund's total annual cost as a percentage of the money invested) to be LOW. 10-20 base points (0.1-0.2%) considered as good, 30-40 (0.3-0.4%) is moderate/usual. Do not mix up it a. with the management fee, which is usually only a part of the TER b. with any other marketing values, which are as good as ever useless and misleading data, c. Calculate your return is easy: take the benchmark performance (return) minus TER! For example, the
benchmark rose 10% last year, TER of your ETF is 0.4%, your return is 9.6% wich is the value increase of your fund.

4. Spread (difference between selling and purchase price) to be low. 1% considered as acceptable (maximum). Lower is better.

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5. The size of the fund to be big. Leading ETFs have a value (NAV Net Asset Value) of billions of USD or EUR, which means a high liquidity and helps keeping costs down. 6. High turnover/ liquidity: can be critical if the paper quickly to sell. 7. The unit price of the fund (not too big compared to the money to invest - else rebalancing may suffer). Take care of this when giving the transaction order (number x unit price = money to invest). 8. Are the ETFs youre going to buy available on the platform you use and are the trading conditions fine for you? 9. Does the fund fit for your Investment Policy Statement, that is meets the target asset class / portfolio mix youre looking for. 10. Does the fund reinvest dividends or interest payments or pay them off? This may effect your tax positions. 11. Does the fund do security lending, if yes, is there a collateral covering the credit risk? 12. Does the fund track the benchmark index well (tracking error)? 13. Are you clear about the profiles of the FS providers involved in fund transactions (e.g. historically reliable, no bailout needed in crisis times, good reputation, good indicators, etc.), are this profiles acceptable for you? a. Fund manager b. Custodian c. Sponsors (EU) / AP Authorized Participant (US) d. here a sample for profile evaluation 14. Is the basic investment (the index) in that currency you seek, which can be different from the currency which the fund nominated/listed in. For example, an S&P ETF invests in US dollars, but listed in Euro on Xetra Frankfurt. 15. Has the fund sound historical track records (not new)? 16. Taxable payments like dividend or interest or capital gain or other (personal income) tax matters (investors domicil, market place tax laws, DTA) to apply? 17. Compare fund data shown on the funds website, the trading platform you use and the exchange the fund traded on. Screen for ETFs on aggregator websites like http:// www.etfinfo.com/ or http://screen.morningstar.com/etfselector/ 18. Prior to your transactions a) set up and observe/monitor simulated portfolios b) start with small(er) amounts (e.g. a few hundreds or thousands of dollars) and rather with well known funds (e.g. S&P 500, DAX etc.) or funds you feel yourself familiar with. 19. Be aware, your broker/advisor/planner might be no fiduciary 20. ...
Criteria listed above are not exhaustive and comparing particular ETFs is a complex process: usually we arent looking for the best (often there is no best), but for one or more funds fitting for your IPS Investment Policy Statement rp. target portfolios you seek, their asset classes or portfolio mixes defined by the IPS. For your general investment knowledge consider this world-class sources: TER, CMH, Passive investing, Morningstar-MSN, Morningstar Investing Classroom, Time Hale.
"If you only ever read one book on Investing Should Be this the one." Book Review of Smarter Investing by Tim Hale http://www.healyourinvestments.com/ A story your banker will never tell you. More on ETFs: http://www.indexuniverse.com/webinars/on-demand-webinar-playback.html

Zoltan Luttenberger KFC. 2011, 2012

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