Risks of Exchange Traded Funds

General

As the underlying holdings of an ETF are openly traded securities, they will be vulnerable to market price fluctuations and the value of the investment may rise or fall in value and neither the capital or income is guaranteed. Although ETFs will closely track an index, during times of market volatility, the tracking accuracy of an ETF may be affected.

Counterparty risk

The ETF will not always physically hold the underlying assets and therefore there is a risk that a counterparty could default which could result in a loss not represented by the underlying index.

There has recently been an example of this where a number of ETCs provided by ETF Securities had to be temporarily suspended in the week commencing 16th September 2008. The ETFS Commodity Securities provided by ETF Securities are priced using commodity futures rather than physical commodities. The futures are currently provided by AIG, an American insurance company, which ran into financial difficulties. This caused the market makers, who essentially determine the quoted price of the shares, to become concerned about dealing with them, leading to a temporary suspension of some ETFS Commodity Securities. AIG was subsequently rescued by the US Federal Reserve and all of the suspended ETFs have since resumed trading.

This illustrates how counterparty risk can potentially affect an investment and that where a physical asset is not backing the investment the investor is reliant on the financial strength of a counterparty to meet their obligations. It was AIG in that instance but this risk is just as applicable to all funds which rely on a counterparty. ETFS Securities have since re-structured their ETFS Commodity Securities accordingly by ensuring that their counterparty, AIG, provides 100% capitalisation for their etfs (please see ETFS Commodity Securities prospectus for information on how this works).

Currency

If the ETF's underlying investments are in a currency different to the ETFs denominated currency (i.e. portfolio exposure to yen but ETF denominated in euros), there will be an additional currency risk to consider when making the investment.

Volatility

ETCs are generally higher risk investments, which can experience high volatility, with the possibility of commodity price movements over 10% in a day. This is not normal on a daily basis but is an indication of how volatile they are. For this reason it is sensible to set yourself price targets when you first make an investment as to the level at which you wish to sell to realise gains or limit losses. Other more mainstream ETFs, such as a FTSE 100 ETF, will also experience volatility but it is likely to be to a lesser extent.

Short/Leveraged ETFs

Short and leveraged ETFs are more complicated investments which carry greater risks. Leveraged investments will exaggerate market movements and therefore be very volatile with higher levels of risk and potential reward. Losses with a leveraged ETF can be accumulated at a much quicker rate and there is a greater chance that investors will lose all of their capital. Because both short and leveraged ETF price movements are calculated using a daily percentage, for periods of more than one day it is possible that they will ''outperform'' or ''underperform'' the relevant index or commodity. Leveraged ETFs are intended for institutional and sophisticated investors and you should read the relevant individual leveraged ETF prospectus to ascertain suitability and the risks that are involved.

Tax

Tax is subject to change which could affect your investment in the future.

More on the risks of ETFs

The prospectus will give more information on the risks of the ETF or ETC. You can access the majority of these from the Research tab on the price page for each stock on our website, alternatively you can find it using a search engine such as Google.