Although ETFs are in general simple, transparent and low cost there are a number of features you should consider before investing. Further information on each of these can be found on the ETF factsheets which should be read, alongside the simplified prospectus, which are available from the issuers website.
ETFs are traded like shares and may not be for everyone. They closely track the performance of an index and as such their value can go down as well as up and you may get back less than you invested. If you are unsure about the suitability of ETFs for your own investment needs you should seek independent financial advice.
Counterparty Risk - while most ETFs do not use leverage and achieve their objectives by purchasing a diversified pool of assets, for example the individual stocks that make up the FTSE 100, some achieve their objectives through the use of derivatives, typically swaps, which carry counterparty risk. If the counterparty (issuer of the derivatives) does not pay the sums due, the investor will see a reduced return regardless of the performance of the underlying assets. A number of ETF issuers seek to mitigate the counterparty risk by posting collateral, that is, setting aside a pool of assets that the investor can claim on in the event of the issuer’s default. In these instances, care must be taken to ensure that the collateral will perform as desired and investors’ attention should be paid to the quality of the collateral to establish whether it would continue to hold its value were the issuer to default. Full details can be found in the issuers simplified prospectuses which can be accessed from websites.
Leveraged and Short ETFs – some ETF providers offer leveraged (where gains or losses can be magnified), and inverse (or short) products. ETFs that offer leverage, or that are designed to perform inversely to their underlying index or benchmark, are highly complex financial instruments that carry significant risks. These securities may not be appropriate for many investors, especially for those who plan to hold them longer than one trading session.
Leveraged and inverse ETFs have unique compounding, daily reset and leverage features that may significantly amplify risk, particularly for medium and long-term investors, and in periods of high market volatility. Before investing in any leveraged or inverse ETF, you should read the prospectus carefully.
Taxation - you should be aware that the majority of ETFs are Offshore Funds and as such specific taxation rules apply for investors subject or potentially subject to UK tax. As a general point, some (but not all) ETFs have obtained ‘Distributor Status’, which means that gains on their disposal should be subject to Capital Gains Tax (CGT). A new Reporting regime is being introduced to supersede the Distributor rules and, again, some (but not all) ETFs may get Reporting Status, which likewise should secure CGT treatment for any gain on disposal. For any Offshore Fund which has not had Distributor Status and/or Reporting Status throughout an investor’s period of ownership, a gain on disposal should be taxable as income. You should familiarise yourself with these rules and consider them in the context of your own individual circumstances before making an investment decision. Please be aware that Barclays Stockbrokers does not give tax advice and the status and tax treatment of ETFs may change in the future.
The iShares PDF “Tax Update: New UK Reporting Funds Regime” provides general information on the taxation of ETFs and iShares’ interpretation of the impact on their ETF range
For information on the status of a specific ETF with regard to taxation please refer to the factsheet and simplified prospectus as provided by the ETF issuer on their website.
