What are ETFs?

An Exchange Traded Fund (ETF) is a security that comprises a whole range of other securities – such as individual shares or bonds – in order to track an underlying index. ETFs are similar in many ways to traditional investment funds, but they are listed on stock exchanges, tradable at any time and much cheaper than the traditional alternative.

What is an index?

An index is used to track the performance of a group of assets, such as shares, using a standardized methodology. Typically, an index represents a specific market segment. However, there are also indices that track entire markets. For example, the Wilshire 5000 attempts to represent the entire US stock market, while the S&P 500 limits itself to the 500 largest US companies.

An index functions like a basket of shares and contains those securities that influence the development of a specific market. Indices can also track the performance of foreign currencies, bonds or commodities.

Because indices give investors a good overview of the economic development of markets, they are also referred to as stock market barometers. Indices serve as an important benchmark for investors to assess the performance of investment products such as mutual funds.

What is the difference between the DAX and the TecDAX?

The DAX contains the 30 largest German companies by market capitalization and is frequently used to track the development of the German economy as a whole.

If, on the other hand, you are particularly interested in the development of the German technology sector, the TecDAX, which contains Germany's 30 largest technology companies, is particularly suitable. Since some of the DAX corporations are based in the technology sector, they can also be found in the TecDAX. For example, Deutsche Telekom and SAP are included in both the DAX and the TecDax.
This shows: An index always tracks a very specific market segment. The values contained can appear in several indices.

This always depends on which market segment the index wants to track.

Diversify easily with index funds

Those who invest in the capital market often do so with the aim of profiting from a growing global economy and participating in corporate profits. To achieve this, however, an individual investor would have to purchase thousands of shares to cover the entire global economy. This would be associated with enormous effort and high costs.

But there is a simple solution: index funds. An index fund is an investment fund whose portfolio is designed to track its respective benchmark index as closely as possible. This means that the fund provider acquires exactly those shares or securities that are included in the corresponding index. In the case of the DAX, these would be the 30 DAX companies.

Because an index is often representative of an entire market, investors can use an index fund to invest in the entire market with just a single security, without having to purchase each security individually. True to the motto: Why look for the needle in the haystack when you can buy the whole haystack.

What distinguishes passive from active funds?

Passive investment strategyIndex funds pursue a passive investment strategy. This means that they track the underlying index as closely as possible, based on the composition of the index. Which titles are selected for the fund is therefore already defined quite precisely by the index. This strategy involves comparatively little effort and low costs, as not every title has to be analyzed individually. This saves effort and costs, which is why the management fees of index funds are often comparatively low.

Active investment strategy

Actively managed investment funds also offer investors the opportunity to invest in a broad portfolio. Active management means that fund managers select individual titles with the aim of beating the market. Active fund managers are always on the lookout for the “best” individual stocks that achieve the highest performance. Active managers make decisions largely independently of indices.

Do active or passive investment strategies offer the greater benefit?

As a rule, putting together the portfolio for active funds involves a lot of effort and high costs, which are usually passed on to the customers – i.e. the end investor – in the form of higher management fees.

What are ETFs?

Exchange Traded Funds (ETFs) or, in German, exchange-traded index funds, are a special type of index fund and can be understood as a further development of these. Just like conventional index funds, they replicate a specific index and pursue a passive investment strategy. ETFs differ from traditional index funds in that they are traded on the stock exchange and thus receive additional liquidity.

In addition to the favorable cost structure, ETFs have another decisive advantage: they can be traded freely on the stock exchange just like other securities. Normal index funds as well as actively managed funds can usually only be sold and bought once a day.

Due to the tradability, investors always remain flexible with ETFs and can receive liquidity quickly if required.

Example: From index to ETF

The fund provider acquires all 30 DAX individual stocks and bundles them in a DAX ETF. Investors have the opportunity to acquire this and thus invest directly in the German market as a whole with a single investment. Because the fund provider replication specifically the index in the portfolio selection and all index stocks are included in the ETF, this is passive management.

What exactly do ETFs track?

Through ETFs, whole indices, such as the German DAX or the US Dow Jones,以及 individual markets can be replicated. ETFs are passively managed funds, which means that the composition of the funds only changes if the underlying index also changes. For example, if an investor purchases an ETF on the German benchmark index DAX, they participate directly in the price fluctuations of the index. If the price of the DAX falls by 0.5%, then the price of the ETF also falls by 0.5%. If the value of the DAX rises by 2%, so does the value of the ETF.

Basically, a distinction can be made between different types of ETFs. In addition to the classic equity ETF, there are a variety of other product categories, such as bond ETFs (from companies, states or municipalities), sector ETFs (e.g. technology, finance or retail), commodity ETFs (such as crude oil or gold), currency ETFs or even inverse ETFs (profits from falling prices).

1. Physical replication: Through physical replication, the ETF acquires exactly the securities of the respective index with the corresponding weighting.

2. Synthetic replication: Synthetic replication also mirrors the performance of the index, but through financial instruments that do not exist in the index itself. Key tracking takes place via a exchange transaction (“total-return-swap”). Through a contract with a credit institution, the latter undertakes to pay out the difference in the index yield in exchange for a fee or to withdraw it in the event of a price decline.