Which ETF providers do you use to invest?

SCM Direct only invest in UCITS IV ETFs for its GBP portfolios.

In all portfolios, we NEVER invest in any ETF that is either leveraged (i.e. which aim to magnify the movements in markets through borrowing) or inverse/short ETFs (that aim to make money when the benchmark being tracked falls in value).

SCM Direct is not biased towards any one ETF provider. We seek out ‘best of breed’ for all the ETFs we select for our portfolios.

What happens to any income received from dividends and interest on cash balances?

There are two forms of ETF with regards to dividends; accumulating and distributing funds.

Accumulating funds roll any dividends up inside the ETF so the price of the ETF reflects a total return.

Distributing funds pay dividends out to investors at regular intervals (monthly, quarterly, semi-annual or annual).

Where dividends are paid out to investors, this additional income is paid into the cash component of the portfolio and reinvested into the portfolio.

What are ETFs and what’s the difference between an ETF and a traditional mutual fund?

ETF stands for Exchange Traded Fund. These products trade throughout the business day on stock exchanges like individual company shares. The ETFs within the GBP portfolios are all UCITS IV regulated thereby providing investors with a high level of regulatory protection.

ETFs track the performance of their benchmark index, thus the performance of a FTSE 100 ETF for example, will normally closely follow the performance of the underlying FTSE 100 benchmark index, less its fees. In contrast, a mutual (non-index) fund often invests in a much more concentrated range of securities resulting in its performance often being markedly different (either positively or negatively) to its benchmark.

The main advantages of ETFs over many traditional ‘active’ mutual funds is that they can be traded on a stock exchange throughout the business day rather than just once a day, they tend to charge significantly lower fees, trade their underlying holdings much less thereby saving trading costs, tend to be much more diversified and are normally much more transparent as they normally disclose all their holdings daily.

An excellent guide can be found at the London Stock Exchange ETF Guide

There are different types of ETF; which types does SCM Direct invest in?

Whichever is best for the particular market. There are two main types of ETF – physically backed and synthetic ETFs.

 
Physical ETFs invest in the actual underlying securities to replicate the underlying index (sometimes this process is ‘optimised’ whereby not every single index constituent is held to reduce overall costs).

 
Synthetic ETFs use an investment product known as a swap to replicate the underlying index and may directly hold a different portfolio of securities to the index being tracked.

 

SCM Direct invests in both types of ETFs, assessing each structure and underlying index as part of a thorough due diligence process. SCM Direct only invests in a synthetic ETF when its third party ‘counterparty risk’ is 100% collaterised through the fund holding a basket of liquid securities to mitigate this ‘counterparty risk’.

How safe are ETFs and what are the risks?

SCM Direct only invests in ETFs. We do NOT invest in any ETNs (Exchange Traded Notes) as we believe the risks associated with such products as being much too high. SCM Direct only invests in UCITS IV ETFs for its GBP based portfolios to provide additional investor protection.

 
The price of the ETF depends on the value of the underlying investments and the demand for the ETF shares in the market, and the share price may therefore be at a discount or premium to the fund’s asset value. Some ETFs are more thinly traded than others, which may affect their liquidity, especially in a market downturn. Although ETFs normally have a low tracking error, i.e. a measure of how consistently it follows its benchmark, during times of market volatility the tracking error of an ETF may increase.

 
The value of the investment may rise or fall in value and neither the capital nor income is guaranteed.

 
Typically, ETFs try to replicate a stock market index such as the FTSE 100 or the Hang Seng Index, a market sector such as energy or technology, or a commodity such as gold or petroleum. Accordingly, if such index, sector or commodity price fluctuates, so will the value of the ETF.

 
There may also be a counterparty risk as some ETFs generate additional revenue by lending out some of their investments. Similarly, some ETFs seek to achieve their objectives through the use of derivatives, which carry counterparty risk. In either case if the counterparty defaults, the investor may see a reduced return regardless of the performance of the underlying assets. To mitigate the counterparty risk providers or lenders post collateral by setting aside a pool of assets that the investor can claim on in the event of the issuer or lender’s default. SCM Direct only invests in those ETFs that hold a minimum of 100% collateral posted daily.

 
Leveraged and Short ETFs can often be more complex financial instruments that may significantly amplify volatility and therefore risk. For this reason, SCM Direct does not invest in any leveraged or short ETFs.

 
If the ETF’s underlying investments are in a currency different to the ETF’s denominated currency (i.e. portfolio exposure to Sterling but ETF denominated in Euros), there will be an additional currency risk to consider when making the investment as exchange rates may cause the value of overseas investments and the income arising from them to rise or fall.

Sign up to our monthly factsheets