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For professional clients only An Introductory Guide Exchange Traded Funds

Exchange Traded Funds - HSBC...Exchange-Traded Funds (ETFs) started to be used in Europe in the early 2000s but over the past few years they have grown their share of the investment

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Page 1: Exchange Traded Funds - HSBC...Exchange-Traded Funds (ETFs) started to be used in Europe in the early 2000s but over the past few years they have grown their share of the investment

For professional clients only

An Introductory Guide

Exchange Traded Funds

Page 2: Exchange Traded Funds - HSBC...Exchange-Traded Funds (ETFs) started to be used in Europe in the early 2000s but over the past few years they have grown their share of the investment

Exchange-Traded Funds (ETFs) started to be used in Europe in the early 2000s but over the past few

years they have grown their share of the investment market significantly. This trend has been supported by investors’ increasing focus on costs as well as growing evidence of index-based strategies presenting a strong

viable alternative to other type of funds investing across developed markets.

ETFs are listed on a stock exchange, meaning that they are bought and sold like shares. However, in contrast to UK equities, ETFs are exempt from Stamp Duty so

investors do not have to pay this tax when they buy the fund through their broker or a fund platform. This does not mean though that ETFs do not pay Stamp Duty on equity purchases within their portfolio; indeed they do

but that cost forms part of their price.

Being listed on a stock exchange also adds a certain level of transparency compared to non-listed

investment vehicles. ETFs are priced throughout each trading day, rather than only once a day as is the

case with most mutual funds. This can add a layer of comfort, particularly in times of high volatility, that an investor can sell or buy its ETF investment at a

particular point in time during a trading day.

In addition, investors typically get totally up-to-date information on ETF holdings whereas mutual funds

disclose this usually only once a month, and even then this tends to cover only the largest holdings.

Page 3: Exchange Traded Funds - HSBC...Exchange-Traded Funds (ETFs) started to be used in Europe in the early 2000s but over the past few years they have grown their share of the investment

Exchange Traded Funds 3

Investing in an ETF: why do it and howWhy invest in an ETF? ` Access to markets

A huge spectre of ETFs available means that there are funds

enabling access to many different markets. There are broadly-

based ETFs that provide exposure to whole regions or even

the entire asset class of global equities as a whole, as well

as more focused funds that invest only in single countries or

sectors of industry.

` Determining the timing of your trades

Given ETFs’ continuous pricing, investors can buy or sell

their ETF shares at any time when the market is open. This

is important particularly during the times of high volatility,

when share prices can fluctuate significantly in the course of

a trading day.

` Transparency

Investors can get real-time information on an ETF’s holdings.

This can help in making a better-informed decision about the

composition of an investment portfolio.

` Economies of scale

As with any shares, investors pay a fixed broker’s fee every

time they buy ETF shares, and that fee does not depend on

the size of investment. Therefore, compared to mutual funds,

which charge an initial fee as percentage of the amount

invested, ETFs present economies of scale.

Know How

Physical or Synthetic Index Replication?

Today, there are two main ways a fund can replicate an index,

by either buying the underlying assets in that index or by using

derivatives to mirror the performance of that index. The first

method is known as physical replication and the second is

synthetic.

When a fund uses full physical replication, all the underlying

assets are held in the proportion equal to their weighting in the

index. However, when the index contains so many constituents

that trading them runs the risk of eroding fund performance

(MSCI World Index with its 1,612 constituents is a good

example1), holding only a proportion of the underlying index

might be a better alternative. This can be achieved through an

optimisation process.

Synthetic ETFs rely entirely on the use of derivatives. They buy

swap contracts where the other side, a counterparty, commits

to pay the fund daily returns equal to the performance of the

benchmark index, and all dividends. For this, the ETF pays the

counterparty a fee and the performance of the physical assets

it holds, and all the dividends they generate. However, there is

always a risk that a counterparty does not honour its contract and

defaults on its obligations.

We believe that buying all of the stocks in the underlying index

in the same proportion as the index is the best approach to

take, as it allows us to construct funds with a high degree of

transparency and simplicity, without compromising their ability

to track an index closely. In our view, the risks associated

with synthetic replication – the most important of which is

counterparty risk – are not worth being exposed to.

The importance of due diligence

ETFs may differ from mutual funds in the way they are traded

and structured but products from different providers may vary

just as much as mutual funds. In order to incorporate high quality

ETFs into a portfolio, the funds will need to be evaluated as

thoroughly and diligently as in the case of active or index mutual

funds. Investors should also consider spreading the risk by

dividing their ETF exposure between different providers.

Among the key factors that need to be considered as part of due

diligence are:

` Underlying index and its coverage

` Provider’s rules determining index composition – they govern

which companies are included in an index and which are left

outside its scope

` Liquidity of the underlying market

` Fund costs

When it comes to comparing fund costs, we believe it should

be done based on ETF’s total cost of ownership. This way, a

comparison would take in account not only management fees

and the Ongoing Charges Figure (OCF), but also transaction

costs.

ETF’s total cost of ownership comprises the costs of holding and

trading the fund. The first category would include the OCF and

rebalancing costs, while the second one will cover transaction

costs, any additional brokerage commission, tax and currency

fluctuations if applicable.

1 Source: MSCI as at 31 July 2014.

Page 4: Exchange Traded Funds - HSBC...Exchange-Traded Funds (ETFs) started to be used in Europe in the early 2000s but over the past few years they have grown their share of the investment

The design of our ETFs reflects your and your clients’ views and requirements.

We have committed to only use physical replication for our ETFs.

We also pay a lot of our attention to the fact that fees have a significant impact

on investment returns over a long term. ETFs costs are generally relatively low but, nevertheless, there is a wide range of fees charged by ETF providers. We draw on our scale and operational efficiency to deliver highly competitive all-inclusive fees. Our

overall underlying objective is to offer great value for money on all of our ETF products.

Our range of physical ETFs offers a range of features and benefits that our clients have

asked for.

Page 5: Exchange Traded Funds - HSBC...Exchange-Traded Funds (ETFs) started to be used in Europe in the early 2000s but over the past few years they have grown their share of the investment

Exchange Traded Funds 5

ETFs from HSBC: A Competitive EdgeTransparency ` Every HSBC ETF publishes a full list of securities that it holds

on a daily basis, in addition to up to date fact sheets on our

website www.etf.hsbc.com

` Our fee structure is transparent: the OCF comprises the

management fee and a list of other costs carried by the asset

manager which include administration, custody and audit

fees, legal, regulatory and registration expenses. There is no

entry or exit fee.

` As ETFs trade on stock exchanges, they are subject to a

bid-offer spread and broker commissions in the secondary

market. In the primary market investors will be charged the

creation or redemption fees in addition to the brokerage

commission. Creation/redemption fees are charged by the

Authorised Participant to cover transaction costs, custodian

fees and taxes where applicable. These fees are available

on request.

Cost effectiveness ` We keep our charges to an absolute minimum by harnessing

our global capabilities and existing local expertise worldwide,

especially in the emerging markets. This results in very

competitive OCFs on most of our funds.

Accurate index tracking ` We apply our robust quantitative portfolio management,

trading and risk monitoring processes to ensure the

efficiency of HSBC ETFs both in terms of tracking difference

and tracking error.

Asset allocation building blocks ` For each of our ETFs we have selected indices that we

believe our clients find most relevant for each of the

underlying markets. Therefore, our ETFs can be used by

clients as effective building blocks for globally diversified

equity portfolio.

Liquidity and accessibility ` In addition to other market makers, HSBC Global Banking and

Markets is committed to providing liquidity and competitive

spreads on exchange.

` Our ETFs are listed on the main European exchanges and

registered for sale in several more European markets to

make it easier for clients to access them.

Controlled risk ` All our ETFs use physical replication so our funds do not carry

derivative counterparty risk which is normally associated with

synthetic ETFs.

Did you know?In Europe we offer a wide range of equity ETFs, ranging from the major developed markets to single emerging markets such as

Brazil and Russia. Our HSBC MSCI Russia Capped UCITS ETF was the first Russian ETF available in Europe that tracks the locally

listed market and is composed mainly of local Russian stocks. The ETF uses full physical replication.

HSBC only offers ETFs that invest physically in relevant stocks. We don’t offer swap-based ETFs since we believe that the

physical approach allows us to deliver products that are inherently simpler and better understood.

Page 6: Exchange Traded Funds - HSBC...Exchange-Traded Funds (ETFs) started to be used in Europe in the early 2000s but over the past few years they have grown their share of the investment

6 Exchange Traded Funds

An investment partner you can trustChoosing the right exchange traded fund (ETF) for your

investment portfolio is about selecting the right investment

partner that can offer products with attractive features. HSBC

ETFs are managed by HSBC Global Asset Management, a

leading global investment manager that has a long track record

of providing sound investment solutions to a wide range of

investors around the world. We manage over 800 investment

funds in more than 20 countries and territories around the world.

ETFs have a clear role within our suite of investment funds. And

since we don’t just manage ETFs, we aim to bring you and your

clients the benefit of our experience and scale in managing a

diverse range of investment products worldwide.

We have been managing ETFs since 2003 after launching our

first products in Hong Kong. Since 2009 we have been offering

ETFs in Europe.

Our European ETF range covers all the main developed and

emerging equity markets.

HSBC ETFs: Keys Facts ` Physical-only investment approach

` High levels of transparency

` Highly competitive all-in fees

` Coverage of developed and emerging markets

` Sharp focus on risk control

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Exchange Traded Funds 7

Key RisksMarket risk:

The value of investments and any income from them can go

down as well as up, and investors may not get back the amount

originally invested.

Investment horizon:

Stockmarket investments should be viewed as a medium to long

term investment and should be held for at least five years.

Currency risk:

Where overseas investments are held, the rate of currency

exchange may cause the value of such investments to go down

as well as up.

Emerging market risk:

Investments in emerging markets are by their nature higher

risk and potentially more volatile than those inherent in some

established markets.

Geographic risk:

Some of the funds invest predominantly in one geographic area;

therefore any decline in the economy of this area may affect the

prices and value of the underlying assets.

Performance risk:

Past performance is not an indication of future returns.

Page 8: Exchange Traded Funds - HSBC...Exchange-Traded Funds (ETFs) started to be used in Europe in the early 2000s but over the past few years they have grown their share of the investment

8 Exchange Traded Funds

This document is intended for professional clients only and

should not be distributed to or relied upon by retail clients.

The material contained herein is for information purposes only

and does not constitute investment advice or a recommendation

to any reader of this material to buy or sell investments. Care has

been taken to ensure the accuracy of this document, but HSBC

Global Asset Management accepts no responsibility for any

errors or omissions contained therein.

Fund information

HSBC ETFs are sub-funds of HSBC ETFs plc, an investment

company with variable capital and segregated liability between

sub-funds, incorporated in Ireland as a public limited company,

and authorised by the Central Bank of Ireland. The company

is constituted as an umbrella fund, with segregated liability

between sub-funds.

Shares purchased on the secondary market cannot usually

be sold directly back to the Company. Investors must buy and

sell shares on the secondary market with the assistance of an

intermediary (e.g. a stockbroker) and may incur fees for doing so.

In addition, investors may pay more than the current Net Asset

Value per share when buying shares and may receive less than

the current Net Asset Value per Share when selling them.

All applications are made on the basis of the current HSBC ETFs

plc Prospectus, relevant Key Investor Information Document

(“KIID”), Supplementary Information Document (SID) and Fund

supplement, and most recent annual and semi-annual reports,

which can be obtained upon request free of charge from HSBC

Global Asset Management (UK) Limited, 8 Canada Square,

Canary Wharf, London, E14 5HQ. UK, or from a stockbroker or

financial adviser. Investors and potential investors should read

and note the risk warnings in the prospectus, relevant KIID, SID

and Fund supplement. UK-based investors in HSBC ETFs plc are

advised that they may not be afforded some of the protections

conveyed by the Financial Services and Markets Act (2000), (‘the

Act’). The company is recognised in the United Kingdom by the

Financial Conduct Authority under section 264 of the Act.

Restrictions

The shares in HSBC ETFs plc have not been and will not be

offered for sale or sold in the United States of America, its

territories or possessions and all areas subject to its jurisdiction,

or to United States persons. Affiliated companies of HSBC Global

Asset Management (UK) Limited may make markets in HSBC

ETFs plc.

Index disclaimer

The EURO STOXX 50 is the intellectual property (including

registered trademarks) of Stoxx Limited, Zurich, Switzerland and/

or Dow Jones & Company, Inc., a Delaware corporation, New

York, USA, (the “Licensors”), which is used under license.

The securities based on the Index are in no way sponsored,

endorsed, sold or promoted by the Licensors and neither of the

Licensors shall have any liability with respect thereto.

All rights in the FTSE 100 and the FTSE 250 (the “Indices”)

vest in FTSE International Limited (“FTSE”). “FTSE®” is a

trademark of London Stock Exchange Group companies and is

used by FTSE under licence. The HSBC FTSE 100 UCITS ETF

and the HSBC FTSE 250 UCITS ETF (the “Products”) have been

developed solely by HSBC Global Asset Management (UK)

Limited. The Indices are calculated by FTSE or its agent.

FTSE and its licensors are not connected to and do not sponsor,

advise, recommend, endorse or promote the Products and do

not accept any liability whatsoever to any person arising out

of (a) the use of, reliance on or any error in the Indices or (b)

investment in or operation of the Products. FTSE makes no

claim, prediction, warranty or representation either as to the

results to be obtained from the Products or the suitability of the

Indices for the purpose to which they are being put by

HSBC Global Asset Management (UK) Limited. “FTSE®” is a

trade mark of the London Stock Exchange Group companies,

“NAREIT®” is a trade mark of the National Association of Real

Estate Investment Trusts (“NAREIT”) and “EPRA®” is a trade

mark of the European Public Real Estate Association (“EPRA”)

Important information

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Exchange Traded Funds 9

and all are used by FTSE International Limited (“FTSE”) under

licence). The FTSE EPRA/NAREIT Developed® Index is calculated

by FTSE. Neither FTSE, Euronext N.V., NAREIT nor EPRA

sponsor, endorse or promote this product and are not in any way

connected to it and do not accept any liability.

The funds or securities referred to herein are not sponsored,

endorsed, or promoted by MSCI, and MSCI bears no liability

with respect to any such funds or securities or any index on

which such funds or securities are based. The Supplement to

the Prospectus contains a more detailed description of the

limited relationship MSCI has with HSBC ETFs plc and any

related funds.

Standard & Poor’s and S&P are registered trademarks of

Standard & Poor’s Financial Services LLC (“S&P”) and Dow

Jones is a registered trademark of Dow Jones Trademark

Holdings LLC (“Dow Jones”) and have been licensed for use

by S&P Dow Jones Indices LLC and sublicensed for certain

purposes by HSBC Global Asset Management (UK) Limited.

The S&P 500 and the S&P BRIC 40 are products of S&P Dow

Jones Indices LLC, and have been licensed for use by HSBC

Global Asset Management (UK) Limited. HSBC Global Asset

Management (UK) Limited’s HSBC S&P 500 UCITS ETF and

HSBC S&P BRIC 40 UCITS ETF are not sponsored, endorsed,

sold or promoted by S&P Dow Jones Indices LLC, Dow Jones,

S&P, their respective affiliates, and neither S&P Dow Jones

Indices LLC, Dow Jones, S&P, their respective affiliates make

any representation regarding the advisability of investing in such

product(s).

To help improve our services and in the interests of security, we

may record and/or monitor your communications with us. HSBC

Global Asset Management (UK) Limited provides information

to institutions, professional advisers and their clients on the

investment products and services of the HSBC Group.

This document is approved for issue in the UK by HSBC Global

Asset Management (UK) Limited, who are authorised and

regulated by the Financial Conduct Authority. HSBC Global Asset

Management (UK) Limited provides information to institutions,

professional advisers and their clients on the investment

products and services of the HSBC Group.

Copyright © HSBC Global Asset Management (UK) Limited 2014.

All rights reserved.

www.assetmanagement.hsbc.com/uk

25934-FP14-1442 expiry 23/09/2015

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Notes

10 Exchange Traded Funds

Page 11: Exchange Traded Funds - HSBC...Exchange-Traded Funds (ETFs) started to be used in Europe in the early 2000s but over the past few years they have grown their share of the investment

Notes

Exchange Traded Funds 11

Page 12: Exchange Traded Funds - HSBC...Exchange-Traded Funds (ETFs) started to be used in Europe in the early 2000s but over the past few years they have grown their share of the investment

ContactFor more information, please contact us:

Email: [email protected]

Telephone: +44 (0) 207 024 0435

Website: www.assetmanagement.hsbc.com/passive