Tips on risk avoidance and ETF selection criteria

Speaking out on the recent developments within the European ETF market, Valérie Baudson, Managing Director of ETFs with Amundi, said that identifying the risks to which ETFs are exposed is one way to ensure investors avoid them.

First of all, she said, it is essential to differentiate between ETFs, which are UCITS-regulated funds, and other exchange-traded products such as ETNs, ETPs, ETCs, which do not stick to the same set of guidelines in terms of index structure methodology, diversification ratios, counter-party risk disclosure requirements nor documentation.

Baudson went on to explain to the Edhec-Risk Institute that as with any investment product, ETFs are not immune to exposure to certain risks and it is incumbent upon providers to disclose these in full to their clients. She said that there have been recent reports highlighting the requirement for both improved transparency and a clearer understanding of the nature and level of risks related to ETFs, whatever their structure, particularly in the areas of liquidity and counter-party exposure.

When it comes to the most important ETF selection criteria which should be taken into account, Baudson believes the one of the first elements to be examined by investors is the whole area of cost. The most obvious component of this, she says, is the TER as it is deducted directly from the NAV and has a direct impact on tracking error. Investors also look closely at bid/offer spreads on the order book.

Another key factor which will affect performance is the quality of replication. Investors should be analysing essential indicators such as tracking error, dividend optimisation, the type of indices being replicated, and the quality of counter-parties.

And, finally, the ETF provider’s reputation as well as its capacity to provide a comprehensive and consistent range of products are both important considerations in the selection process.