A Look at Exchange Traded Funds ("ETF")
Not so long ago the concept of an exchange traded fund was simply a idea in a financial engineers mind. I remember looking at the market years ago and wishing that I could buy a basket of securities replicating the Dow Jones Industrial Average. It was just a dream. But when it comes to financial engineering dreams can come true, and it did.
So many of these products were launched over the years to the point that the number of them outstanding in pretty close to mind-boggling. So another dilemma has developed as to how to pick the right ETF.
But my purpose here is to look at the ETF from the perspective of keeping tracking of the financial condition of my clients. ETFs in and of themselves do not create any particular accounting/bookkeeping issues apart from those that I have already mentioned, but here are a few pointers to keep in mind:
Many ETFs offer divdend reinvestment options. It's extremely important to keep track of these dividend re-investments. Quite often shares are purchased with the dividends without the cash ever passing through the account. It's necessary to keep track of the dividends as they will affect the cost of your investment. Normally the reporting of these dividends is pretty clear and there is a lot of historical information available. This is clearly less of an issue in non-taxable accounts.
For ETFs traded on foreign stock markets there will be an issue with the deduction of non-resident withholding tax at source. It will be necessary to ensure that someone advises the payor of your location. There are often tax treaties in place that will impact the amount of non-resident withholding tax. Please be sure that you obtain any relief available.
Amounts paid need to be properly documented as it may impact the amount of any foreign tax credits that are available when you file your personal tax return.
There is, however, an interesting spin on ETFs that you should be aware of.
Here is an interesting Financial Times article that you should be aware of: "Record growth for exchange traded funds despite regulatory fears".
The Securities and Exchange Commission last month issued a report examining the role ETFs played in the wild price moves that severely disrupted trading on Wall Street on August 24.
The fear is that the structure of ETFs and index funds could worsen market shocks when they happen.
SEC commissioner Luis Aguilar said at the end of last year of the August disruption: “Why ETFs proved so fragile that [August] morning raises many questions and suggests it may be time to re-examine the entire ETF ecosystem.”
The ETFGI figures show that BlackRock, the world’s largest fund manager, was the fastest-growing ETF provider for a second year, with its iShares operations pulling in a record $139bn in 2015, up 36 per cent on 2014.
“We saw new records established for ETF asset gathering in Europe, Canada and Japan, with growth from multiple sources. ETFs are now even available in Iran,” said Deborah Fuhr, co-founder of ETFGI.
A record number of companies (43) entered the ETF market last year.
Growing dissatisfaction with high fees in the traditional fund market and increasing investor awareness of active managers’ inability to beat their benchmarks has helped spur growth of the ETF market.
The interesting point to note here is that during the Great Depression in 1929 one of the contributing factors to the stock market crash was the creation of the investment trusts at the time. The investments trusts brought new meaning to the word leverage and with the deleveraging of the investment trusts the stock market decline was greater than one might have expected.
"An exchange-traded fund (ETF) that uses financial derivatives and debt to amplify the returns of an underlying index. Leveraged ETFs are available for most indexes, such as the Nasdaq-100 and the Dow Jones Industrial Average. These funds aim to keep a constant amount of leverage during the investment time frame, such as a 2:1 or 3:1 ratio."
