ETF-Selection | Haobin Tan

Find the Right ETF

Fri, 07 Mar 2025 00:00:00 +0000

💡Take Away

Particularly important criteria for selecting an ETF include its
- costs,
- fund size
  - A threshold of €50 million is considered sufficient.
  - Over €100 million is considered stable.
  - Over €150 million is a safe benchmark for larger funds.
- replication method
You can find this information in the ETF factsheet, on the provider’s website, or conveniently in our ETF search.
Knowing the tracking difference can help with selection. The distribution type is also part of the selection process based on personal preference.
Fund domicile and currency have less impact when choosing an ETF but can still serve as decision-making factors.

👉 How to Proceed

Use the search function at your broker or in ETF search to find suitable ETFs. Filters help narrow down the selection.
Then, compare the key facts listed in the factsheets or ETF search results.
Once you’ve chosen an ETF, you can buy or set up a savings plan for it using its ISIN at your broker, making it part of your portfolio.

Fund Volume: Bigger is Better

The term “fund volume” describes how much money is invested in an ETF.

A fund volume of €114 million means that a total of €114 million is invested in that ETF.
The fund volume indicates how established the ETF is in the market—the larger, the more established.
For ETFs tracking large global indices, the key threshold is around €100 million.

The larger an ETF, the more profitable it is for the provider. This can also benefit investors in terms of lower costs.

If an ETF does not perform as expected, the provider may remove it from the market. In such cases, investors are informed in advance (with a six-week notice period), allowing enough time to reallocate funds. -> So, no need to panic.

However, a small fund volume is not necessarily a disadvantage.

Many niche ETFs, though small, still perform well and remain profitable for providers.
A threshold of €50 million is considered sufficient. In general, a fund volume of over €150 million is a safe benchmark for larger funds.

Costs & Fees of ETFs

The costs of an ETF consist of

transaction costs for buying and selling shares

Occur once when buying or selling and depend on the brokerage account
- Some brokers offer commission-free ETFs, while others charge a flat fee or a percentage-based fee
Some brokers may charge an account management fee

the Total Expense Ratio (TER) of the ETF

Charged by the ETF provider and can be found in the ETF factsheet
Represents the total annual costs of an ETF, covering the fees the provider deducts directly from the fund volume to cover expenses

the spread as a price factor

The difference between the bid and ask price
It can become a significant cost factor, especially outside official trading hours and on weekends.

ETF savings plans have significantly changed cost structures. Compared to traditional order fees, they are often much more cost-effective for retail investors 👏.

Accumulating or Distributing?

If an ETF holds dividend-paying stocks or a bond ETF receives interest, there are two distribution methods to handle these earnings:

Accumulating (reinvesting): The ETF automatically reinvests the received dividends or interest, allowing the invested capital to grow.
- Ideal for long-term investors who want to grow their capital through the power of compound interest.
Distributing: The ETF pays out the dividends or interest directly to investors.
- Suitable for investors looking to generate a regular passive income from their investments.

Utilizing the Saver’s Lump Sum with distributing ETFs

By smartly distributing investments across both types of ETFs, one can invest in a tax-optimized manner. For all the important tax aspects of ETFs, check out guide on ETF & Taxes.

Overview of Replication Methods

The principle of ETFs is to replicate a specific index as accurately as possible, which is known as replication.

Common replication methods are

physical (full) replication

Replicate the index by holding physical securities in the same proportions
This is advantageous because it can most accurately reflect the values.

optimized sampling

Securities are also physically bought, but only the most important ones. Which ones are selected is determined by the sample.
This is particularly beneficial for ETFs with many securities.
This method helps reduce costs.

synthetic replication (swap ETFs)

Replicates the index using swaps (exchange transactions)
Mainly useful for niche markets and commodity ETFs
Sometimes, these replication methods are also combined, with larger positions held physically and smaller ones replicated synthetically.

Tracking Error and Tracking Difference: Deviation from the Index

One criterion for evaluating the quality of an ETF is the Tracking Difference

Measures the difference between the ETF’s performance and its benchmark index over a specific period
Can be positive (meaning the ETF outperforms its index) or negative
Various factors contribute to the Tracking Difference, including general costs, the replication method, and differences in withholding tax between the ETF and the index.
Although Tracking Difference and Tracking Error are often confused or used interchangeably, they represent different metrics!
Since the Tracking Difference does not show actual costs but rather opportunity costs (i.e., the theoretical lost returns), the Total Expense Ratio (TER) remains the primary cost metric for private investors.

Tracking Error vs. Tracking Difference

Metric	Definition	Focus	What It Measures	Ideal Scenario	Influenced by
Tracking Difference (TD)	The average difference between the ETF’s returns and the index’s returns over a period of time.	Long-term deviation	Measures the ETF’s overall performance compared to the index -> Shows whether the ETF outperforms or underperforms its benchmark.	Should be low and stable, ideally close to 0 or slightly positive.	Fees (TER), taxes, and reinvestment strategies.
Tracking Error (TE)	The volatility (standard deviation) of the ETF’s return deviations from the index’s return.	Short-term fluctuation	Measures how volatile the ETF’s tracking is on a daily, weekly, or monthly basis (using standard deviation) -> Measures how consistent the ETF is in tracking the index.	Should be as low as possible, indicating stable tracking.	Liquidity, market impact, and trading costs

Low TD + Low TE = A high-quality ETF ✅
Low TD but high TE: The ETF tracks the index well over time, but with significant short-term fluctuations 📈.
High TD but low TE: The ETF is stable but consistently lags behind the index (likely due to high fees).

For long-term investors, TD is typically more important than TE. However, if TE is too high, it may indicate that the ETF is not reliably tracking the index.

The Role of Currencies in ETFs

A currency often appears in the name of an ETF, such as EUR or USD. This is the fund currency, meaning the currency in which the fund’s assets are managed. However, the settlement is always done in the currency of your broker, so with a German broker, it would be in euros.

Due to the investment in securities in foreign currencies, there is a certain currency risk.

This reflects the possibility that the home currency’s exchange rate may rise relative to the foreign currency, thus reducing the value of the shares.

However, when investing in many ETFs (such as global ETFs), there is already strong diversification (including in terms of covered currencies). -> Currency risk often becomes a zero-sum game, and additional insurance only reduces returns.

The Fund Domicile

You can find out the so-called fund domicile by checking the ISIN, i.e., the International Securities Identification Number.

The first two letters indicate the fund domicile, for example, “DE” for Germany or “IE” for Ireland.

Most funds are established in Luxembourg or Ireland.

Luxembourg has long been established as a fund location, which is particularly advantageous for institutional investors.
Ireland offers slight tax advantages for certain securities transactions with the USA, which is why it is also an established fund domicile.

However, overall, it can be said that the significance of the fund domicile has strongly diminished for German investors, as German funds are no longer given tax preference. Only ETFs with a non-European fund domicile can cause difficulties, but these are rarely or never offered by German brokers. 🙄

Using the ETF Search Tool

ETF search from Finanzfluss

Which ETF is right for me?

The factsheets can be very helpful

They always include key information such as the performance of the benchmark index or the fund volume
They are kept up to date

It is always advisable to check with the factsheet or other documentation from the provider.

Reference

ETF Auswahl: So findest du den richtigen ETF

Fund Volume

Fri, 07 Mar 2025 00:00:00 +0000

💡Take Away

The fund size describes how much invested money is in an ETF.
ETF providers may remove ETFs from the market if they perform poorly. This risk is higher for new and small ETFs. We recommend ETFs with a fund size of at least €100 million.
ETFs with a large fund size usually have lower costs due to economies of scale.
If an ETF is liquidated, you will receive your money back and can reinvest it in a new ETF.

The more, the better

The fund size describes how much money all investors have collectively invested in an ETF. The higher the volume, the lower the fixed costs for the fund providers. These lower costs can then be passed on to investors.

ETFs with a high fund size often have a low Total Expense Ratio (TER). This scaling effect benefits you because it reduces the portion of your returns eaten up by costs.

Some ETFs of large fund size:

Providers test ETFs in a kind of trial period

Currently, over 2,900 ETFs are approved in Germany alone. Some of them focus on specific niches, industries, or regions. However, not all of these ETFs are successful in the long run.

That’s why providers test how an ETF performs over a certain period. If it fails to establish itself or does not attract enough capital, the provider may remove the ETF from the market.

What happens when an ETF is liquidated?

When an ETF is liquidated, the invested capital is sold off and returned to the shareholders. As an investor, you do not lose your money, but you will need to find a new ETF. However, reinvesting your money may incur additional costs.

If an ETF is set to be closed, the provider will notify you in advance. The notice period is six weeks. During this time, you should look for a new ETF that aligns with your investment goals. Once you have found a suitable ETF, you can reallocate your investment. After the notice period ends, the provider stops trading the ETF and liquidates it. Your previously invested capital is then returned to your brokerage account.

The Right Fund Volume

Experts assume that a fund volume of at least 100 million euros makes an ETF profitable for providers. From this point, an ETF is also relatively safe from liquidation.

As a rule of thumb, the larger the fund volume, the more established, liquid, and secure the ETF is. For niche ETFs, the fund volume may be smaller, but the management costs are usually slightly higher.

Reference

Warum das ETF Fondsvolumen entscheidend ist

Costs and Fees with ETFs

Fri, 07 Mar 2025 00:00:00 +0000

💡Take Away

When selecting ETFs, the Total Expense Ratio (TER) is an important decision-making criterion. You can find it in the factsheet.
The TER summarizes all management costs charged by your ETF provider. The provider deducts these costs annually from the fund volume.
It’s best to trade during the official exchange hours of the reference exchanges, otherwise, you may pay more for securities due to a higher spread.
Transaction costs arise when buying and selling. They consist of custody fees and exchange fees.

Overview of the main costs:

Cost Type	Description	Cost Center
Transaction Costs	Purchase and sale fees / Custody fees	Custodian Bank
Total Expense Ratio (TER)	Includes management fees, marketing budget, index licensing fees	ETF Provider
Spread & Exchange Fees	Difference between buy and sell price	Exchange

Transaction Costs and Custody Fees

Depending on the broker you use to buy and store your ETFs, additional transaction costs and custody fees may apply.

For each transaction, i.e., when buying or selling securities, brokers may charge an order fee. This fee is set by the broker themselves.
Some newer providers, such as Neo-brokers and Smart brokers, often offer very low fees, free savings plans, and free custody accounts.

Therefore, it is important to compare different brokers before making a decision!

Total Expense Ratio (TER)

The Total Expense Ratio (TER) is the overall cost ratio. The ongoing costs of an ETF include

licensing fees
marketing fees
administrative costs

For example, the iShares Core MSCI World ETF has a TER of 0.2%. If you invest €10,000 in this ETF, your annual total cost would be €20.

The ETF provider deducts the fees from the fund itself. Therefore, the TER is not deducted directly from your account; instead, the fund volume decreases. In other words, you pay with a slightly lower fund performance.

Since 2004, ETF providers are legally required to disclose the TER. You can find it in the fund prospectus, on the provider’s website, or in the ETF’s factsheet—anywhere the ETF is listed.

The Spread Between Bid and Ask

In stock trading, there are always two prices: the buy price and the sell price.

The demand side wants to buy the stock and offers a certain amount of money, known as the bid price.
The stock owners make an offer. The lowest price on the offer side is called the ask price.

The difference between these two prices is the spread, also known as the bid-ask spread. For the buyer, it is beneficial if both prices are as close to each other as possible.

Outside of the regular trading hours of major exchanges like Xetra, less trading occurs. Some marketplaces take advantage of this by offering longer trading hours. During this time, the spread is usually wider. The spread when trading outside of regular market hours can make a significant difference!

When trading outside regular hours, the spread often increases because there is less liquidity, meaning fewer buyers and sellers. As a result, the difference between the bid and ask price widens, which can increase the cost of executing a trade.
Example: Left: normal trading day; Right: weekend

The Right Time to Trade

Traditional financial institutions typically trade on major national exchanges, such as those in Frankfurt or Stuttgart.

Xetra, the trading platform of Deutsche Börse AG, is the leading venue for trading stocks and ETFs. Here, a large volume of stocks change hands daily, and due to the high trading volume, the spreads are relatively low.

Recently, so-called neo-brokers have started to disrupt the market. These neo-brokers include platforms like Trade Republic, Scalable Capital, and Smartbroker.

For example, Trade Republic executes its trades through the electronic trading system of the Hamburg Stock Exchange, LS Exchange. Through this, you can trade from 7:30 AM to 11:00 PM.
However, the reference exchange, Xetra, is only open from 9:00 AM to 5:30 PM. During Xetra’s hours of operation, the spreads on LS Exchange are aligned with those on Xetra. When Xetra is closed, the spreads on LS Exchange may widen, meaning you will pay more than necessary!

Savings Plans Avoid Unnecessary Costs

ETF savings plans are unaffected by the off-exchange spread risk. They are always executed during the official trading hours of the reference exchanges.

Are ETFs Cheaper Than Individual Stocks?

Depending on whether you’re following a stock or ETF strategy, different costs apply.

Individual Stocks	ETFs
Transaction Costs	Relatively high
Management Costs (TER)	None
Spread & Exchange Fees	Depends on the exchange

If you buy many stocks yourself, you’ll incur higher transaction fees. However, with an ETF savings plan, these fees can be completely avoided.
Individual stocks don’t have ongoing management costs like the TER (Total Expense Ratio) of ETFs.

If you want to diversify globally, ETFs are the way to go: buying thousands of individual stocks would be expensive and time-consuming.

Reference

Welche Kosten und Gebühren gibt es bei ETFs?

Distributing or Accumulating ETFs?

Fri, 07 Mar 2025 00:00:00 +0000

💡Take Away

The stocks contained in ETFs pay dividends, which you, as an investor, benefit from.
Distributing ETFs pay out the dividends to your account.
Accumulating ETFs reinvest the dividends, meaning they buy more shares.
For passive income, distributing ETFs are suitable. If you want to build wealth, accumulating ETFs are more beneficial.
For most indices, ETFs are available in both variants.

What happens to dividends in ETFs?

Companies can share their profits with shareholders by distributing dividends. Shareholders receive a certain amount of money based on the number of shares they own.

An ETF consists of thousands of individual stocks. When a company pays dividends to an ETF, these dividends belong to the ETF investors. An ETF can handle these earnings in two ways:

Distributing ETFs: The ETF pays out the dividends to its investors. Depending on the ETF, investors receive payments annually, quarterly, or even monthly.
Accumulating ETFs: The ETF reinvests the dividends by purchasing more shares. This increases the fund’s total assets (fund volume). This process is known as accumulation (thesaurierung).

Distributing ETFs: Dividends Paid to Your Account

Distributing ETFs regularly pay out their earnings directly to your settlement account. -> You have full control over how to use this money—you can either reinvest it or spend it elsewhere. If you choose to reinvest the dividends, transaction costs may apply.

For investors using German brokers, taxes on earnings from distributing ETFs are automatically deducted, making the process convenient. However, if your broker is based abroad, you must report these distributions in your tax return.

Because of their regular payouts, distributing ETFs are ideal for generating passive income.

You can treat these payments like a salary from employment.
They are especially popular among older investors, who often use them as a form of retirement income.

Accumulating ETFs: Dividends Are Reinvested

The key advantage of accumulating ETFs is that you, as an investor, benefit from the compound interest effect.

Earnings, such as interest and dividends, are automatically reinvested into the ETF.
As the ETF’s value grows, so does the value of your ETF shares. This means you also earn returns on the reinvested dividends, allowing your money to work for you and generate long-term returns.
The longer your money remains in a profitable accumulating ETF, the greater the compound growth effect.

Since you do not receive cash payouts from accumulating ETFs, you do not immediately realize taxable gains. The overall tax burden during the accumulation phase remains significantly lower compared to distributing ETFs, as taxation is initially minimized.

A Simplified example (with considering tax) to compare distributing and accumulating ETF:

	Distributing ETF	Accumulating ETF
ETF Price	€100	€100
Dividend Received	€5	€5
Paid to Your Account	€5	€0 (Reinvested)
New ETF Price	€100	€105
Total Wealth	€105 (€100 ETF + €5 cash)	€105 (all in ETF)

Which is better?

If you want to build wealth, an accumulating ETF is the better choice. Over the years, you benefit from compound interest, which can significantly boost your returns. Additionally, you save on transaction costs that might occur if you manually reinvest dividends.
If you want passive income, a distributing ETF is more suitable. You receive regular cash flow, but to generate enough income to live on, you need to invest a large amount.
- With a distributing ETF, you can also make better use of the €1,000 annual tax-free allowance, as you receive dividends directly.

Accumulating vs. Distributing ETFs

	Accumulating	Distributing
Use of earnings	Earnings are automatically reinvested in the ETF	Earnings are paid out; some providers offer automatic reinvestment
Compound interest	Yes	Optional (only with reinvestment)
Taxation	Advance lump sum plus capital gains tax upon sale	Tax allowance on earnings is considered by the broker; capital gains tax on each distribution as well as upon sale

Reference

Ausschüttende oder thesaurierende ETFs?

Replication Method of ETFs

Fri, 07 Mar 2025 00:00:00 +0000

💡Take Away

To replicate an index, there are 3 different methods:

Physical replication buys the index in the same weighting. Such replication is called fully replicating ETFs.
With sampling, the ETF provider only buys a selection of the securities. They exclude those with a very small share in the index.
Swap ETFs providers enter into a swap agreement with a financial institution. Swap ETFs are mainly used in niche ETFs.

ETFs aim to replicate the performance of an index as accurately as possible. There are different ways to achieve this goal. The method by which an ETF bundles and represents price movements is called the replication method. You can read about the replication method of an ETF in its factsheet.

An index can be replicated by an ETF in three different ways. The deciding factors are how accessible the securities are and how expensive they are. If a stock is on a market that is difficult to access from abroad, ETF providers need to be creative. ETF providers choose between

physical replication
optimized sampling
synthetic replication

Physical Replication

Physically replicating ETFs track the index by purchasing all the securities included in it. Because these ETFs mirror the index exactly, they are referred to as fully replicating or full-replication ETFs.

Example: If an ETF aims to physically replicate the DAX, it buys all 40 stocks included in the index. The weighting of each stock in the index determines its proportion within the ETF. If a company drops out of the DAX and another one is added, the ETF sells the outgoing stock and buys shares of the newly included company. The same applies when there is a rebalancing within the DAX.

Each transaction incurs fees, which affect the Total Expense Ratio (TER) of the fund. These fees are deducted from the fund’s assets and impact its performance.

In niche markets and for hard-to-replicate securities, costs are often higher than for Dow Jones stocks or those from similarly established indices.
The DAX, with its 40 components, is relatively manageable, keeping costs low.
However, global ETFs containing hundreds or even thousands of securities face higher costs, making physical replication more suitable for smaller indices.

Sampling

Sampling is an advanced form of physical replication.

The ETF still purchases securities physically, but only a representative subset. With this “sample,” the provider makes a preselection, which is why this approach is also called optimized sampling or optimized physical replication.
Instead of including all the securities in the index, the ETF invests only in the most significant ones.
- A security is considered important if it has a high weighting in the index.
- Illiquid securities or those with a very small share of the index are disregarded.
Example: in the MSCI Emerging Markets Index, many stocks have a weighting of just 0.01%. This index includes stocks from countries with less liquid and accessible markets compared to Europe or the US. An ETF using the sampling method ignores these minor components since they have minimal impact on overall index performance. This approach helps ETF providers reduce transaction costs.

Synthetic Replication

Some markets are difficult to access due to low liquidity or regulatory restrictions. This includes asset classes such as commodities or money market interest rates. However, investors still want to gain exposure to these indices through an ETF. In such cases, an ETF can replicate an index using a swap agreement.

The ETF provider enters into a swap deal with a counterparty, usually a major financial institution. The counterparty holds the desired assets, while the ETF itself maintains an independent collateral portfolio.
The two parties sign a contract: the ETF provider delivers the return of the collateral portfolio to the counterparty and, in exchange, receives the return of the target index.

Example

Let’s say you invest in a synthetic MSCI China ETF, but the ETF does not directly purchase Chinese stocks. Instead, the process works as follows:

This ETF might hold European corporate bonds as its collateral portfolio.

The ETF provider signs a swap agreement with a bank (e.g., Deutsche Bank), which agrees to provide the returns of the MSCI China Index. In return, the ETF provider gives the bank the returns generated by the collateral portfolio (the European bonds).

As a result, the price of your ETF moves in line with the MSCI China Index, even though the ETF itself does not own any Chinese stocks.

The value difference between the two portfolios must not exceed 10% under EU regulations.

If the swap portfolio is at €100 and the collateral portfolio is at €110, the swap must be executed at this point at the latest. The same applies if the swap portfolio is at €100 and the collateral portfolio drops to €90.
Most ETF providers execute swaps well before reaching the 10% threshold.
With swap-based ETFs, there is always counterparty risk, meaning the possibility that the financial institution involved in the swap could go bankrupt. However, both parties provide collateral, which is usually more valuable than the swap transaction itself, reducing the overall risk.

Comparison of Replication Methods

Replication Method	Description	Typical Distribution Type	Application Examples
Physical Full Replication	The index is replicated with all its constituent securities in the same proportions.	Distributing or accumulating	Small indices with a high proportion of blue-chip stocks: DAX, Euro Stoxx 50, Dow Jones 30
Optimized Sampling (Physical)	The ETF replicates the index with a selection of the most important index securities.	Distributing or accumulating	Larger number of blue-chip stocks: MSCI World, MSCI Emerging Markets
Synthetic (Swap ETFs)	The index is replicated through swap agreements.	Primarily accumulating	Niche markets and specialty ETFs: FTSE Vietnam, MSCI Emerging Markets, Leverage or Short ETFs

Which replication method is the best?

The replication methods have little impact on ETF performance. The replication method also doesn’t make a difference in terms of taxes.
Physically replicating ETFs are a good choice because they replicate indices so accurately.
If you want to invest in niche markets, you often can’t avoid swap ETFs.

Good to know: ETFs and the associated underlying portfolios are considered special assets in Germany. However, the outstanding swap difference is not. If the counterparty goes bankrupt, the ETF could, in the worst case, lose the outstanding swap return. Although the likelihood is low, you should check what collateral the respective ETF has deposited.

Reference

ETF Replikationsmethoden im Vergleich

Tracking Difference & Tracking Difference

Fri, 07 Mar 2025 00:00:00 +0000

💡Take Away

The Tracking Difference refers to the difference in performance between an ETF and its benchmark index over a given period. It is influenced by factors such as transaction costs from rebalancing, taxes, or cash holdings.
You can use the Tracking Difference to assess the quality of an ETF’s index replication.
The Tracking Difference usually needs to be calculated by yourself. The necessary performance data can be found in the factsheet.
The Tracking Error refers to the annual deviation of the daily returns of the ETF and the benchmark index. It indicates how much the Tracking Difference fluctuates.

An important quality feature for ETFs is the so-called Tracking Difference, the performance difference between the ETF and its benchmark index. In combination with the Total Expense Ratio (TER), you can determine if poor index replication is causing you to miss out on potential returns.

Tracking Difference in ETFs

What is tracking difference?

ETFs aim to replicate an index as accurately as possible. However, this is never perfectly achievable for several reasons. Therefore, the value progression of the ETF will always differ slightly from that of the index. 🤪

The Tracking Difference shows the difference between the performance of the ETF and that of the benchmark index. The causes for this can include

fees
the handling of foreign withholding taxes
income from securities lending

Sometimes, ETFs even outperform the benchmark index.

Where does the Tracking Difference come from?

ETF providers generally try to keep the tracking difference as low as possible, as investors compare it with other ETFs and choose the one with the better value. The following factors can influence the tracking difference:

TER (Total Expense Ratio)

The total expense ratio reduces the returns of an ETF. The lower it is, the smaller the impact on the fund’s performance.

(Source) Taxes

Differences between the calculated and actual taxes can lead to discrepancies in the ETF.

Replication

Depending on how an ETF replicates an index, different costs may arise. With physical replication, many securities may need to be bought, leading to high transaction costs.

Cash Drag

Cash holdings from dividend payouts cause delays, leading to deviations.

Timing

Rebalancing the ETF due to changes in the benchmark index can contribute to the difference.

Securities Lending

By lending securities, ETF providers can generate additional income, allowing them to (temporarily) outperform the benchmark index.

Tracking Difference and TER

To illustrate the costs of an ETF,

the Total Expense Ratio (TER) is usually the first metric considered.

It indicates how much an ETF costs per year.
However, the TER alone is only partially meaningful when assessing opportunity costs—missed profit opportunities.

The tracking difference, which is also a useful metric for evaluating an ETF’s quality, reflects this “missed return” by comparing the ETF’s performance to that of the index

If the tracking difference in the past was significantly higher than the TER, opportunity costs were incurred, meaning potential gains were lost.
However, these figures are based on past performance and cannot be directly projected into the future.

When determining actual costs, the TER still remains the most reliable metric. You can compare the tracking difference with the TER to get a clearer picture.

Finding the Tracking Difference

Find in the factsheet
Browse through ETF platforms

⚠️ These figures should be taken with caution, as they are based on independent calculations rather than official data from the fund provider. As a result, the calculations may be inaccurate.

Calculating the Tracking Difference

Here, we take the iShares Core MSCI World ETF with ISIN IE00B4L5Y983 as an example. The TER (Total Expense Ratio) for this ETF is 0.2%.

Formula for calculating the tracking difference:

$$ \text{Tracking Difference (TD)} = \text{Fund return} - \text{Index return} $$

$\text{TD} > 0$: The ETF has outperformed the index.
$\text{TD} < 0$: The ETF has underformed the index.

We compute the tracking difference for the past year:

$$ \text{TD} = 10.42\% - 10.41\% = 0.01\% $$

$\text{TD} = 0.1\% > 0$ indicates that the ETF has outperformed its benchmark index. In this case, the ETF has performed better than expected, making it more cost-effective for investors.

Tracking Error

The Tracking Error, also known as the replication error, is a related metric. It is often mistakenly used interchangeably with the Tracking Difference.

The Tracking Error measures how much the Tracking Difference fluctuates over time.
A lower Tracking Error means the ETF replicates its benchmark index more accurately.
A higher Tracking Error indicates that the ETF tracks the index less reliably, sometimes performing better and sometimes worse than the benchmark index.

Tracking difference vs. tracking error

The Tracking Difference refers to the actual performance difference between an ETF and its benchmark index over a given period.
The Tracking Error, on the other hand, measures the variability of these performance differences over time, indicating how the Tracking Difference has fluctuated.

Reference

Tracking Error & Tracking Differenz erklärt

Currency Risk

Fri, 07 Mar 2025 00:00:00 +0000

💡Take Away

Anyone investing globally automatically invests in countries and companies with currencies other than the euro.
Currency pairs like EUR/USD can fluctuate, representing both a currency risk and an opportunity.
By diversifying globally and investing for the long term, investors balance out currency risks and opportunities, making it unnecessary to hedge against such fluctuations.
The fund currency of an ETF is purely cosmetic and does not represent either a risk or an opportunity—it is irrelevant.

What Role Does Currency Play in ETFs?

When you invest in companies outside the Eurozone through an ETF, you introduce various currencies into your portfolio—this comes with currency risk.

The fund currency, meaning the currency in which an ETF is listed, does not matter. A US dollar-denominated ETF carries the same currency risk as its euro-denominated counterpart if they track the same index.

World ETFs bring many different currencies into your portfolio

The major advantage of world ETFs is broad diversification: You automatically invest in different countries, continents, and therefore, various currencies. For example, the MSCI World includes companies like Apple (USD) and Nestlé (CHF), along with many other currencies.

This introduces both currency risk and currency opportunity into your portfolio.

Currency risk can slightly reduce your returns if exchange rates move unfavorably, and depending on your investment amount, it may have an impact. However, this risk shouldn’t keep you up at night.

As an investor, it’s essential to understand the role of different currencies in your investments. All securities within an ETF have a “home currency,” but companies are exposed to currency fluctuations as soon as they operate internationally. For example, Apple sells its products worldwide and generates revenue in multiple currencies. The same applies to other companies like Samsung or Nestlé. Globally operating companies can hedge against such currency risks.

Indirect Hedging Against Currency Risk

If you invest in the MSCI World, you have a portfolio with exposure to multiple currencies and a certain dependence on the US dollar. However, upon closer examination, many individual securities within the index are already highly diversified in terms of currency.

Currency Risk Is Also an Opportunity

What exactly is meant by currency risk? Whenever you invest in securities outside the Eurozone, you take on this risk. It refers to the possibility that your home currency—such as the euro in Germany and Austria—appreciates against the currency of your investment.

Example

Let’s say you own 100 shares of an ETF that tracks the U.S. Standard & Poor’s Index, such as the Vanguard S&P 500 UCITS ETF. If the U.S. dollar weakens against the euro, the value of each of your 100 shares decreases. If you were to sell at that point, you would incur a loss due to the unfavorable exchange rate movement.

However, the opposite scenario is also possible: If the U.S. dollar strengthens against the euro, your shares become more valuable in euro terms.

Fund Currency of an ETF

The fund currency of an ETF refers to the currency in which the fund’s assets are managed by the ETF provider. This is typically the same currency used in the index that the ETF tracks. You can usually recognize this in the ETF’s name or, at the latest, in the ETF’s factsheet.

However, for you as an investor, this is not relevant. Your broker settles in your home currency, which in Germany is the euro. The fund currency is essentially a marketing tool to suggest more security and does not protect you from currency risk 🤪.

Example

To convert the returns of a US-dollar-denominated ETF to euro, the rough calculation goes like this: US dollar return minus 2% = euro return. So, if a U.S. index rises by 5%, your German ETF would only show a 3% return, but in the end, the same amount of money will be received.

Different exchanges trade in different currencies, and the trading currency is indicated by the exchange. For example, on Xetra (Frankfurt) and Paris, the trading currency is always the euro, regardless of the fund currency. However, at the Zurich Exchange, trading occurs in Swiss francs.

Important: Don’t let this confuse you. It doesn’t matter whether you buy an MSCI World ETF in U.S. dollars or euros. It is essentially the SAME product. This is because your depositary bank will convert everything to euros anyway. The fund currency is not relevant to you as an investor.

Exchange Rates are Mathematically a Zero-sum Game

Overall, exchange rates have an expected return of 0% mathematically. This means that, in the long term, no profit is expected from exchange rates. The chance of losing money due to exchange rates is as high as the chance of making money.

How to Manage Exchange Rate Risk with Global ETFs

With ETFs, you have good opportunities to keep currency risk low. You can proceed as follows:

Split your assets across different asset classes and markets with different currencies.
Invest long-term: Over a longer period, currency fluctuations usually balance out.
Optionally: Increase the proportion of European companies in your portfolio. You can achieve this by adding an ETF on the MSCI Europe or Euro Stoxx 600.

In Most Cases Unnecessary: Currency Hedging with Hedged ETFs

If you want to hedge against exchange rate risk, you can use “hedged ETFs,” which protect your assets with other financial derivatives. However, these come with additional fees that can reduce your overall returns.

Hedged ETFs can only eliminate currency risk in the short term, not in the long term. If you’re planning to invest for the long term, we recommend against them. As mentioned, hedged ETFs reduce your returns and are only sensible for short-term speculation, if at all.

Reference

Währungsrisiken bei ETFs

Fund Domicile

Fri, 07 Mar 2025 00:00:00 +0000

💡Take Away

The fund domicile of an ETF can usually be identified by the International Securities Identification Number (ISIN). A country code at the beginning of the ISIN marks the domicile, such as “IE” for Ireland or “LU” for Luxembourg.
ETFs that include UCITS in their name are launched within the EU and are subject to EU regulations. These funds adhere to a uniform standard.
Within the EU, the significance of the fund domicile has somewhat decreased. Many of the ETFs offered in Germany are also domiciled in Germany.
Luxembourg and Ireland play a special role here. Luxembourg’s status is attributed to its strong infrastructure, transparent financial legislation, and its history as a hub for funds. Ireland, on the other hand, offers tax advantages when holding physical stock shares from the USA.
Overall, tax benefits due to the fund domicile are not primary criteria when selecting an ETF, while European origin is more important. For exotic funds, the German tax data is often not maintained, leading to higher tax burdens for investors.

ETF Fund Domicile Explained

The place where an ETF is launched is called the fund domicile.

Many ETFs already include a hint about their place of origin in their name.
- The addition of “UCITS” means that the fund was launched and is operated according to EU regulations. This also implies that the fund is domiciled in an EU country. The national financial supervisory authority is responsible for overseeing the fund.
The fund domicile can also be identified by the ISIN, which is the 12-digit International Securities Identification Number.
- This can be found on every ETF’s factsheet.
- The first two characters are an abbreviation representing the fund domicile. For example, “DE” stands for Germany and “LU” stands for Luxembourg.

Common Fund Domicile: Luxembourg and Ireland

It is noticeable that certain countries appear frequently when scrolling through the lists of available ETFs. One of them is

Luxembourg

Luxembourg has earned its good reputation as the home of many funds over several decades
Arne Scheehl from Lyxor ETF also emphasizes the importance of institutional investors who are familiar with the regulations in Luxembourg and, therefore, save a lot of work by investing there.

Ireland

Mainly due to tax reasons: This is especially true for physically held U.S. stocks, and it is related to the double taxation agreement with the United States. This agreement provides slight tax advantages for funds, which can be passed on to investors, giving them a competitive edge.

Fund Domicile as a Decision Criterion

The fund domicile can be considered as one of several quality criteria

In particular, UCITS funds established in Europe offer the benefits of a unified European regulatory framework.
Non-European ETFs are rarely offered by online brokers, which is due to European regulations. However, caution is required: Some of these “exotic” funds are listed on exchanges in the less-regulated over-the-counter (OTC) market.

When it comes to quality features, factors such as cost (TER), fund size, or additional data like tracking difference may be more decisive.

Reference

Fondsdomizil bei ETFs

How to Read ETF Factsheet

Fri, 07 Mar 2025 00:00:00 +0000

💡Take Away

All information about an ETF can be checked in the corresponding factsheet.
Each ETF carries a unique twelve-digit ISIN (International Securities Identification Number).
Every security in Germany also carries a six-digit WKN (Securities Identification Number).
In the factsheet, you can find the most important product information, such as: distribution type and frequency, replication method, costs (TER), and the ETF provider.

There are some mandatory documents that you can find on the profile page of each ETF. However, the factsheet typically provides investors with the best overview. On 1-2 pages, you will learn, among other things, how the ETF is composed, what costs are involved, and more about the characteristics of the ETF.

ETF Name

Each ETF has a unique name for distinction. The naming typically looks like this—before even looking at the factsheet, you can derive the following information: the ETF provider, the index the ETF tracks, the legal structure, and other characteristics (e.g., the replication method or distribution type).

Example:

Trackers: ETF issuer (ETF provider)
MSCI Emerging Market: The index this ETF is designed to track
UCITS: Undertakings for Collective Investment in Transferable Securities, an EU regulatory framework ensuring that the fund meets certain standards of investor protection, making it available for sale across Europe
1C
- 1: typically indicates the currency denomination (e.g., USD or EUR)
- C typically indicates that the ETF is a Accumulating (Accumulation) fund, meaning that any income or dividends earned by the fund are reinvested rather than paid out to investors.

WKN and ISIN

Each security in Germany carries a WKN (Wertpapierkennnummer) or security identification number. This is a six-character combination of numbers and letters that uniquely identifies the security.

The ISIN (International Securities Identification Number) has 12 characters and is used internationally.

National identification numbers like the WKN can usually be converted into an ISIN.
An example of an ISIN is DE 000N252882. The “DE” is the country code, followed by the NSIN (National Securities Identifying Number).

Factsheet: The Most Important Information at a Glance

Let’s take a look at an example ETF factsheet: the iShares Core MSCI World UCITS ETF by BlackRock. Typically highlighted in color, the first page of the factsheet contains the key details of the ETF—the most important information you need to know:

Asset class (Anlageklasse): in this case, equities (as the MSCI World in the name indicates that the MSCI World Index is being tracked)
- With ETFs, you can track different asset classes, such as: equities, bonds, real estate, and commodities.
Share classes (Anteilsklasse): Funds can have different share classes. These are shares in the same fund.
- In this example, both the investment and share class are denominated in US dollars, so no currency conversion fee arises.
- Although different share classes have the same value in an ETF, they may differ in aspects such as profit distribution or the currency used.
Fund’s Inception date (Auflegungsdatum des Fonds): shows when the ETF was launched
- In this example, it has been available since September 25, 2009
- This is important information because with younger ETFs, you should pay close attention to the assets held and the number of shares issued.
- Generally, the risk of the ETF provider going bankrupt is lower with more established funds.
Benchmark index (Vergleichsindex): indicates which index the ETF tracks. In this case, the MSCI world
Total Expense Ratio (TER): The most important metric for the costs of an ETF. It indicates all the costs that the ETF provider deducts from the fund’s assets to replicate the index.
Methodology (Methodik): Indicates the replication method the ETF uses to track the index In this case, optimized sampling.
Rebalancing interval (Rebalancing-Intervall): Indicates how often the ETF provider adjusts the composition of the ETF to match the index
- In this example, the provider rebalances the composition four times a year, as needed, to ensure the ETF closely tracks the index.
Distribution method (Gewinnverwendung): An important criterion when selecting ETFs that align with your strategy.
- In this example, “Accumulating” (thesaurierend) means that the ETF directly reinvests the dividend earnings.

A little further down in the factsheet, you’ll find an overview of the performance, i.e., the ETF’s historical returns.

The first table shows the annual return for the years 2015 to 2019 and compares it with the return of the benchmark index that the ETF tracks (MSCI World in this case).
The second table, which shows the annualized performance, is more relevant for long-term investments
- Here, you can see how much return you would have made each year if you had bought and held the ETF for X years.
- it compares the performance with the return of the benchmark index. You will see that the deviations are consistently below or exactly at 0.11% (tracking difference).

The performance is NOT an indicator of the future performance of the ETF. However, it provides you with a useful reference.

What values are included in my ETF?

Before investing money in an ETF, it is always advisable to check which specific assets it consists of. You can find this information in the factsheet as well.

Example

In our example ETF, which tracks the MSCI World, there are more than 1,600 individual companies included, spread across many countries and sectors. In the factsheet, you will find an overview of the sectors and regions in which your ETF is invested.

Breakdown by sectors

Breakdown by regions

You can see that the MSCI World UCITS ETF from BlackRock has a strong focus on the USA, followed by Japan, and then European countries. In terms of sectors, IT is the largest weight in the example ETF. Health care, financials, and cyclical consumer goods (i.e., things that aren’t essential for survival) are also at the top.

Reference

Wie liest man ein ETF Factsheet?