General and ETFs risks
The following is a list of some of the important risks factors that prospective investors should consider prior to making a decision to invest in ETFs.The list is not intended to be comprehensive or exhaustive. Various other risks also apply, depending on the ETF acquired. You should ensure that you read and fully understand the relevant prospectus and information documents, including the risks associated with the investment prior to making a decision to invest.
All investing involves risk, including the possible loss of money you invest, and past performance does not guarantee future performance. Historical returns, expected returns, and probability projections are provided for informational and illustrative purposes, and may not reflect actual future performance.
FinMarie provides its investment advisory services only to individuals who become FinMarie clients pursuant to a written investment advisory agreement. Articles, commentaries, investment plans and other content provided by FinMarie on or through the Website are for illustrative or educational purposes only and do not constitute investment, legal or tax advice, or an offer to buy, sell or hold any security. Forecasts or projections of investment outcomes in investment plans are estimates only, based upon numerous assumptions about future capital markets returns and economic factors. As estimates, they are imprecise and hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Diversification does not ensure a profit or protect against a loss in a declining market. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Investing entails risk including the possible loss of principal and there is no assurance that the investment will provide positive performance over any period of time.
Special risks of Exchange Traded Funds
Exchange Traded Funds (“ETFs”) are mutual funds traded on the stock exchange that replicate the performance of an index such as the DAX. They are also referred to as passive index funds. In contrast to active investment strategies, which consist of selecting stocks (“stock picking”) and determining favorable times for entry and exit (“market timing”) to achieve “outperformance” versus a benchmark (“benchmark”). Passive investment strategy is designed not to outperform a benchmark index but to replicate it at the lowest possible cost. The following special risks exist with ETFs:
Because ETFs passively replicate an underlying index and are not actively managed, they generally carry the basic risks of the underlying indices. ETFs therefore fluctuate directly in proportion to their basic value. The risk-return profile of ETFs and their underlying indices is therefore very similar. If, for example, the DAX decreases by 10%, the rate of an ETF, reflecting the DAX, will also decrease by around 10%. Or if the ETF tracks overseas assets, changes in the value of the American dollar may also affect the value of your investment. Some funds may be ‘currency hedged’ to reduce this risk.
Some ETFs offer exposure to investments such as small companies, emerging markets or commodities that may be harder to sell in certain circumstances, or more complex and volatile than ordinary company shares. This could increase risks for investors.
Counterparty risk is the risk to each party of a contract that the counterparty will not live up to its contractual obligations. Counterparty risk is a risk to both parties and should be considered when evaluating a contract. Financial investment products such as stocks, ETFs, options, bonds, and derivatives carry counterparty risk.
Such ETFs are 100% exposed to their benchmark, they are, by extension, also 100% exposed to market risks linked to movements in the stocks comprising their benchmark index. Fluctuations in equity markets may lead to substantial variations in net asset values, which may have a negative impact on the ETF’s net asset value. The ETF’s net asset value may fall significantly as a result of the fund being 100% exposed to equity risk. The ETF thus carries a high level of equity risk.
The primary risks involved in trading over-the-counter (OTC) stocks stem from lack of reliable information and the fact that OTC stocks are commonly very thinly traded markets. it’s very difficult for investors to determine the realistic potential of OTC stocks; there is usually very little information readily available. Unlike companies that are traded on regular stock exchanges, OTC companies aren’t required to provide a lot of information. About all that’s required for a company to be listed on the OTC exchange is filling out a form requesting to be listed. This can make it very difficult for the average investor to obtain sufficient information to make an informed investment decision regarding a company. If ETFs and their underlying components are traded on different stock exchanges with different trading hours, there is a risk that transactions in these ETFs will be conducted outside the trading hours of the respective components. This may result in a variation in performance relative to the underlying index.
Securities lending is a simple process that can generate extra returns for ETF investors, but it also introduces extra risk. An equity ETF will typically hold thousands of shares of various stocks. There is a short-seller who wants to borrow those stocks and agrees to post collateral and pay the ETF an additional fee for this transaction.
General risks of open investment funds
As the investment fund is invested in financial instruments, the value of your investment fund units is significantly influenced by economic developments and developments on the capital markets. Even a broad diversification of the investment fund can not prevent a disadvantageous market development leading to a decline in value and thus to a loss of assets.
This is the risk of a downgrading to the credit rating of a private issuer or the risk of its default. Depending on whether the fund is the buyer or seller, the decrease (in the case of a purchase transaction) or increase (in the case of a sale transaction) in the value of the debt securities to which the fund is exposed may result in a fall in the net asset value.
Interest rate risk:
This is the risk of a variation in prices of fixed income instruments resulting from variations in interest rates. It is measured by sensitivity. In periods of interest rate increases (positive sensitivity) or decreases (negative sensitivity), the net asset value may fluctuate significantly.
Shares in open investment funds can normally be returned on each trading day at the respective valid unit value. The unit value is subject to fluctuations. The strength and frequency of these fluctuations is called volatility and is calculated using various historical ratios. Especially with a short-term investment horizon, there is an increased risk of loss in the event of high volatility, as losses in value can no longer be “sit out”. High equity investment funds are generally more volatile than high-rated mutual funds.
The opportunities and the risks of an investment fund increase with increasing specialization on certain investment types (for example, on regions, sectors or currencies), because the specialization reduces the diversification effect.
Risk due to derivatives:
Investment funds may invest in derivatives (e.g., options, financial futures, swaps). The use of derivatives may involve risks that go beyond the risks of other financial instruments.
The terms and conditions of the investment fund may provide that the fund company may, in certain exceptional circumstances, suspend the redemption of the fund units for a maximum of two and a half years. Therefore, during the period of suspension, the fund units can not be returned; when sold on the stock exchange, if it all possible, significant deductions to the actual unit value must be taken into account. Furthermore, as a result of the suspension, the Fund’s assets may even be liquidated, which generally entails asset losses for the investor.
Income generated from investment funds is subject to income tax for the investor. Changes in the tax environment for investment income can lead to a change in the tax burden. In some cases, the returns from trading ETFs may potentially be subject to income tax rather than capital gains tax. The ongoing tax liabilities are determined by both your individual circumstances and the continued status of the exchange traded investment. If you are unsure of your tax liabilities you should consult a qualified tax advisor.