Index funds for investment

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

Those who want to invest free funds have a choice of financial instruments, from the most popular bank deposit to investment in the stock market. If there is no time or opportunity to monitor financial markets every day, then you should consider investing funds for the long term. You can analyze the market yourself and buy shares through a broker, contact a mutual fund or buy index funds.

Definition

An index investment fund (ETF) is a portfolio of securities that form the basis of any index. Stock indices are relative indicators that are formed from the value of securities of "blue chips", that is, the most developed companies in the country. They show the economic situation in the domestic market. Such indices exist in every country. In the USA it is S&P 500, in Germany it is DAX, and in Russia it is RTS and MMBV.

Index funds follow the structure of the underlying index. ATit includes shares of a certain country, region, price, or they are grouped by companies that produce the same goods. The shares included in them can be bought and sold throughout the day. The manager's commission is 0.5% of the asset value. This is the main advantage of ETFs over mutual funds.

The MICEX index includes shares of 45 largest companies. The share of each is determined in proportion to capitalization, but cannot be more than 15%. In the largest companies, a huge share of human labor is concentrated. It forms the value of the shares. The average return on a stock outperforms inflation by 5%. Against this background, speculative methods are more effective. But in the long run, in terms of interest capitalization, a small income will allow you to get a good financial result.

Statistics

The first ETF called TIP 35 was listed on the Toronto Stock Exchange in 1990. It was followed in 1993 by the US SPDR S&P 500, originally called SPY, and the NASDAQ-100. In the 2000s, the investment market developed rapidly. Today there are 4724 investment funds. Their total assets are $2.867 trillion, of which $127 billion is in the S&P 500 alone. Index funds first appeared in Russia in 2013. Then an ETF called FinEx was registered on the Moscow Exchange. In the Russian Federation, the circulation of ETFs is regulated by the Federal Law "On the RZB". Active growth in ETF trading volumes began in 2013. Due to the fact that investors transferred funds from mutual funds to ETFs, the annual trading volumeexceeded $2 trillion, up 27%.

ETF VS Mutual Fund

Index equity funds are similar to mutual funds in a number of ways:

• Professional management (The manager manages the mutual fund, while the ETF is the company that invests in it).
• Low "threshold" of entry (in ETF the minimum contribution is limited by the value of one share, in a mutual fund - the minimum amount is set by the selling agent).
• Asset diversification.

ETFs differ from mutual funds in the following ways:

• High liquidity. ETFs can be sold and bought throughout the day.
• The price of a mutual fund unit is calculated at the end of the day based on the value of net assets. ETF price changes every second.
• Shares of mutual funds cannot be bought with credit money. ETFs can be leveraged.
• Mutual investment funds can only be traded in one country, while shares can be traded on any exchange.
• On mutual funds, unlike ETFs, commissions may be provided.

Market structure

The index fund market is divided into primary (issue and redemption of shares) and secondary (circulation of shares). Only authorized participants have access to the primary market. They initiate the issue of shares, i.e., they exchange cash for shares, and carry out the reverse procedure - they redeem the issue. The shares are redeemed in units of 50,000 shares. Already in the secondary market, legal entities and individuals carry out securities purchase and sale transactions.

Legal Framework

In the US, index funds are regulated by the 1940 law, which de alt withopen mutual funds. Although an ETF does not perform some of the functions of a mutual fund. Sometimes they are created in the form of an investment trust and then registered with the SEC.

European funds operate on the basis of the UCITS Directive, adopted in 2009. Their features: openness to all investors, strict asset regulation and information disclosure procedures. At the same time, a fund opened in Luxembourg or Ireland can circulate throughout the European Union.

Features of operation

Let's take a closer look at how ETFs work. First, the company rarely invests all the funds received from the investor in assets. Most often, 5-10% of the funds raised are used to buy futures for assets that repeat the index. The remaining 90% the company can dispose of at its discretion. But she is obliged to return the investment on demand, taking into account the promised level of profitability. That is, the ETF does not use its funds.

Secondly, most of the funds do not own the Central Bank at all. They synthesize the behavior of the index. For this, an agreement is concluded with the bank on the exchange of cash flows. The credit institution undertakes to ensure the profitability of the index, for which it receives a profit from the fund's assets. 90% of funds are invested in such a virtual portfolio. If the index has brought more income than the portfolio of the Central Bank, then the fund receives compensation from the bank. In the opposite situation, he himself pays the difference to the bank.

Banking risks

The danger is that index funds cannot deviate fromindex. Buying all the shares that are included in the index is expensive. Each manager tries to generate his own portfolio and does not always make an adequate replacement for the Central Bank. It has been said before that not all companies invest in stocks. Some synthesize the index through bank deposits. Such investments are similar in structure to credit derivatives. They also contain hidden risks. If the bank goes bankrupt, then 10% of the collateral will be immediately lost. The rest of the investor will be able to receive in the form of treasury bills.

Issue price

That is. to create an ETF that mimics the RTS, you need to buy an index futures contract. Mutual index funds are cheaper than the assets they replicate. If you bought an asset, you would have to pay $3,000, and if you bought a futures, you would have to pay $300. The remaining funds can be placed on a deposit.

The futures will expire. For example, for RTS it is three months. That is, 4 times a year, you need to transfer the position - change one futures to another. Index funds carry out this operation without the participation of the investor. For carrying out one transaction, the exchange charges 2 rubles. The fund needs to buy and sell futures. That is, the commission will be 4 p. or 0.044% of the investment. For the year you have to pay 0.17%. Only liquid assets should be transferred. And not every index has a futures. That is, to repeat a position, you need to buy several contracts at once or purchase securities on several exchanges. This increases costs.

The owner's account balancefutures changes every day depending on the price dynamics. Reducing the collateral below the set level leads to the fact that the investor must deposit the missing amount, otherwise his position will be forcibly closed at a loss.

An index fund strategy should also include varying contract expiration dates. Against the backdrop of rising prices, the new contract will cost more.

Investment risks

With the "correct" formation of the fund, one should purchase only those instruments that are included in the index, and in the ratio that is inherent in the index. Problem one. The manager should buy shares of companies that are not expected to grow in the next 2 years, just because they are present in the index. The second problem. If a company begins to grow and shows positive dynamics in the market, then the manager cannot purchase shares of this company more than their share in the index. Moreover, when securities rise in price and the company's share in the index exceeds the maximum value, the manager will have to sell these securities.

The bond index fund is out of control. For all other financial institutions, a risk management methodology is applied that limits market presence and losses. In the case of an index fund, you watch the money go down as the index goes down.

How to choose a fund

First of all, the investor should decide in which particular index to invest. Without competent technical and fundamental analysis to deal with thisthe question will be difficult. Index funds work with stocks, bonds, commodities and even real estate. The US PowerShares DB fund monitors the dollar against the euro, yen, pound, krone and franc. Based on the received data, the USDX index is formed. The United States Commodity Index tracks commodity futures, while the iShares Global Real Estate replicates the Cohen & Steers Global Re alty Index. It is better for a novice investor to master the popular S&P 500 or MICEX indices. It is easier to collect information on them and it is easier to compare statistics.

When choosing a fund, you need to pay attention to two criteria: the size of the commission and compliance with the index. The larger the fund, the less likely it is to go bankrupt quickly. General information about Russian funds and mutual funds is presented on the website of the National League of Managers. Although all foundations are required by law to regularly report on the results of their work, after choosing a particular organization, it is still worth checking the financial statements on the website of the foundation itself.

It is also important to pay attention to the minimum deposit. You can become a member of "VTB - MICEX Index" for 5,000 rubles, and "BCS - MICEX" - for 50,000 rubles. Russian funds charge higher fees than US funds. The amount of remuneration includes the commission of the fund, depository, auditor, registrar, appraiser and those expenses that are subject to reimbursement. Their maximum size is specified in the contract itself. For example, in VTB it is 3.7%. Only after a detailed analysis of all the information should a decision be made on whether to investfunds.