Other exchange traded products

Structured products, active ETFs and exchange traded hedge funds

Structured products, actively managed exchange traded funds (Active ETFs) and exchange traded hedge funds are traded on the ASX AQUA market. They may look similar to basic ETFs but they have very different features and risks. Here we explain why they are much more complex than basic ETFs.

Structured products

A structured product is a promise by a company to pay you a return that is usually based on the movement in the value of reference assets such as a share index, security or other asset.

Some issuers also call their structured products names such as 'exchange traded notes', 'exchange traded commodities', 'exchange traded international securities' or 'trackers'. While some of these names sound similar to 'exchange traded funds', these structured products are quite different. 

If the structured product is not fully secured by collateral and it uses derivatives to manage risk, it may be labelled 'synthetic'. Structured products traded on the AQUA market that use derivatives, have to include the label 'synthetic structured product' in their title so you can easily identify them.

Security and collateral

Like synthetic ETFs, structured products may not be backed by physical assets such as cash, bonds and shares. Therefore investors must rely on the creditworthiness of the product issuer or a guarantor such as the issuer's parent company.

Some structured product issuers are 'special purpose vehicles' (sometimes called 'SPVs') with little or no financial substance. These issuers tend to hedge or offset their risk by entering into contracts with third parties. In these cases investors rely on the creditworthiness of the third parties to pay out their investment returns.

Check the product disclosure statement (PDS) to see if the product issuer provides some security for investors.

Structured products will be labelled 'collateralised' when the product issuer's promise to repay investors is adequately secured and the ETF (or issuer as trustee) retains beneficial title to the security collateral at all times. This means that if the issuer's counterparty in an over-the-counter swap arrangement becomes insolvent, investors will have immediate control of the collateral assets.

Counterparty risk

When you buy a structured product you could be exposed to the product issuer's ability to repay you. This is called counterparty risk. Before investing in a structured product consider who the counterparty is, and whether you think they will be able to honour their commitments to investors. For example, if the counterparty gets into financial difficulty, you could lose some or all or your investment.

Counterparty risk may be lower with synthetic ETFs traded on the AQUA market, as Australian Securities Exchange (ASX) requirements restrict the aggregate money owing under derivatives contracts (counterparty exposure). This reduces the risks for investors.

Different requirements to 'physical ETFs'

Structured products are not subject to the same disclosure, Yes governance requirements and investor protections as ETFs.

Active ETFs

Unlike traditional ETFs which are passively managed index tracking funds, Active ETFs (also known as exchange traded managed funds or exchange traded hedge funds) can be bought and sold on an exchange in a similar way to buying and selling units of an ETF.

Active vs passive ETFs

Active ETFs are different to passive ETFs in that they are actively managed to try and outperform an index or achieve some other investment objective, rather than simply track or mimic the index.  Fund managers must make a distinction between an ETF and Active ETF so that investors know what sort of fund they are investing in.

Labelling

Active ETFs traded on the AQUA market have to include the label 'managed fund' in their title, so you can easily identify them. They must also include the word 'synthetic' in their title if they rely on the use of derivatives, instead of holding physical assets to generate performance.

Disclosure and liquidity

Some active ETFs may have different disclosure and liquidity requirements, for example, the fund may delay disclosing details of the portfolio, to protect the intellectual property of the investment managers.

Where the portfolio holdings are not published daily there will be different market making arrangements that may result in increased trading costs and lower liquidity. Investors should carefully read the PDS to understand the differences and additional risks involved.

Exchange traded hedge funds

There may be Active ETFs that are also hedge funds. These products are both actively managed and have features that meet the definition of hedge fund.

Like other hedge funds that are offered 'off exchange', hedge funds traded on the AQUA market use instruments and techniques such as leverage, derivatives and short selling. They must also include the words 'hedge fund' in their title, so you can easily identify them.

Hedge funds are not labelled 'synthetic' even if they rely on the use of derivatives. The use of these alternative strategies means that hedge fund investors can be exposed to more diverse and complex risks than those associated with 'vanilla' managed funds.

Understand these products before you invest

Make sure you understand the nature of the product and risks involved before you invest in structured products, active ETFs or exchange traded hedge funds. If you don't understand how the investment is managed or how the fund manager aims to achieve the promised returns, talk to a licensed financial adviser or don't invest in the product

Before you invest in a structured product make sure you understand the PDS or prospectus and consider getting professional financial advice.


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Last updated: 02 Mar 2017