There is a further need for a financial product that would be appealing for the conservative investor who wants to share in upward market moves. This financial instrument is neither sponsored nor promoted, distributed or in any other manner supported by Deutsche Börse AG the Licensor. Rules for the Construction and Maintenance of the. Liquidating prior to maturity on limited secondary markets can result in losing gains and possibly some principal.


Instead of purchasing all components of the index, the ETF is adjusted by excluding small, non-liquid securities with little influence on index performance, with the index weightings adjusted accordingly. This is because the performance of an index is driven by the heavyweights, which are therefore indispensible for replicating it.

By contrast, securities with a weighting amounting to just a few basis points do not play a decisive role in relation to performance. This approximation, provided that it only produces a minimal tracking error, can save clearing and settlement costs, and can thus benefit the investor. Which securities are selected and which are omitted will depend on the portfolio manager. In addition to the weighting and liquidity, the industry and country weighting also often play a role in the sampling.

The issuer of the ETF enters into a transaction with a swap partner. Depending on whether the index is a stock or bond index, the issuer holds a basket of shares or bonds and swaps its performance for that of the index. Total return swaps are a highly accurate method of tracking non-dividend paying indices so-called performance indices such as the DAX.

Most global indices are price indices, however, that do not take dividends into account, which means that the ETF must make regular payments to investors. In these cases, equity swap ETFs must also have cash on hand to make these payments.

This, in turn, may increase the tracking error. The main source of risk aside from investment risk that investors face in synthetic ETFs is counterparty risk to a certain extent. Should a swap counterparty default, fund shareholders face the risk of permanent capital impairment. Each of these funds has built-in protections against counterparty default.

These are just a handful of the most important safeguards that have been put in place to protect investors in synthetic ETFs from counterparty risk. UniCredit, The un-funded swap model was the first method to be used in Europe to synthetically track the performance of an index. It usually consists of liquid equities and bonds that the investment bank acting as the swap counterparty may have within its inventory.

The securities are held by the ETF in a segregated account at a custodian, where they are regularly monitored and verified. It is important to note that at all times the fund remains the owner of these assets and has direct access to them. This means that if the swap counterparty defaults, in theory, the ETF provider should be able to liquidate the assets swiftly should this option be chosen.

Counterparty risk is measured as the difference between the net asset value NAV of the ETF and the value of the substitute basket in other words, the swap mark-to-market. The swap is marked-to-market on a daily basis and is reset whenever the counterparty exposure approaches the UCITS limit or a lower limit set at the discretion of the ETF provider.

In this case, the fund will ask the counterparty to pay the swap mark-to-market, which the fund will use to buy additional securities for the substitute basket. Resetting to zero involves a payment of 12 from the swap counterparty to the ETF reinvestment in the substitute basket. Resetting involves a payment of 11 from the ETF to the counterparty securities from the substitute basket are sold.

Some providers reset swaps more frequently than others, depending on their own internal thresholds. Finally, swaps are not necessarily reset to zero. Some providers also do not reset the swaps based on the fund owing the swap counterparty money. The counterparty then posts collateral assets in a segregated account with a third party custodian.

The account can be opened either in the name of the fund in the case of a transfer of title or in the name of the counterparty and pledged in favour of the fund. With a transfer of title, the collateral is treated as the property of the fund. This means that if the swap counterparty defaults, in theory, the ETF provider should be able to gain access to the assets without prior approval and dispose of them.

Under a pledge structure, the fund would have to claim ownership of the collateral assets before it can sell them. Enforcing the pledge could take some time and lead to a delay in liquidating the fund if the bankruptcy administrator decides to freeze the assets. The collateral, which is of equal or greater value than the net asset value of the ETF on any given day, is monitored on a daily basis. Whenever the exposure of the ETF to the swap counterparty becomes positive, the ETF provider requests that the swap counterparty deliver additional collateral.

This is to ensure that the level of collateralisation is maintained and the net counterparty risk exposure remains zero, or negative. Swaps can be over-collateralised depending on the assets posted as collateral and the regulation in the country where the fund is domiciled. Most recently some issuers tend to have more than one counterparty for the total return swap. The distribution of the swap over more counterparties intends to reduce the bankruptcy risk.

Equal weight distributions of counterparty-risk is only given at beginning as creation and redemption activities of the respective counterparties could possibly change the distribution.

Ultimately, in the ideal case, the contractual partner guarantees the exact target performance — and the fund manager does not even have to buy and sell stocks to track changes in the index. A stock market sales tax such as the stamp duty in the UK, can also be dealt with by synthetically replicating ETFs: In some cases the one or other replication method has its strengths and weaknesses, finally the investor has to decide under his own restrictions and guidelines what is the right instrument for his portfolio.

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Collectively, the Global Biotech Team covers almost 40 stocks, and in this report, we provide 4 Top Picks: We are hosting a conference call at However, the renewed interest in biotech was transient and the group sold off following 3Q earnings. As the year concluded, the healthcare reform debate that has kept many generalists on the sidelines finally appears to be coming to a close, and the impact on biotech looks quite small.

In , investors witnessed a major shift away from defensive sectors and into cyclicals to capture the recovery from a trough economic period. Cyclicals continue to look more attractive on a valuation basis, with J. The shift into cyclicals in was compounded by uncertainty over healthcare reform and its potential impact to the biotech sector.

Namely, fears over comparative effectiveness policy and limited protection of biologics innovation represented structural risks to the sector. We believe that the cyclical trade is likely to run its course in 1H10, and biotech could rerate in 2H10 as 1 cyclical valuations become less attractive, 2 healthcare valuations remain compelling and 3 the resolution of healthcare reform eliminates uncertainty and appears to be resolving favorably for the industry.

Morgan Equity Strategy estimates, Bloomberg. Healthcare Was a Source of Funds in Biotech underperformance relative to the broader markets in is underscored by the mutual fund flows in the broader equity markets Figure 2 and within healthcare Figure 3. The rally in the broader markets is reflected by consistent fund inflows throughout the spring, followed by profit taking in the summer and continued inflows in the autumn.

In contrast, the healthcare sector continued to see outflows in the spring and ultimately was countercyclical in While healthcare did participate in the market rally to some extent, it remained a source of funds and hence underperformed in The sector is underweighted going into Weekly Mutual Fund Flows: Healthcare Underweighting May Have Bottomed Healthcare weighting peaked for the year in 1Q09 as the presidential budget blueprint triggered a market sell-off on fears around the financial system and significant government intervention in the markets.

However, the ensuing rally triggered a market switch into cyclical stocks at the expense of healthcare. The healthcare weighting in terms of healthcare fund AUM as a percentage of total equity AUM continued to erode throughout see Figure 4.

However, we believe that the weighting trends in recent weeks suggest that valuations in the sector are compelling enough to stabilize the sector weighting and potentially suggest the early signs of a rerating of the sector.

Mutual Fund Healthcare Weighting 0. Large cap biotech weighting eroded in but could rebound The large cap biotech group was a source of funds throughout , but the pressure looks to be stabilizing. On average, the weighting of a large cap biotech stock was consistent for several quarters through 4Q While this analysis supports the notion that large cap ownership has diminished, we note that this analysis is a lagging indicator that is likely to reverse before we have data to reflect the reversal.

Large Cap Biotech Underweighting 1. Multiple Stabilization Could Follow Contraction Large cap biotech stocks not only underperformed the broader markets in but also underperformed the larger names in other healthcare subsectors. We analyzed our collection of the largest names in key healthcare subsectors to assess performance the past two years see Figure 6. Notably, the basis of biotech underperformance in was multiple contraction, while the other major subsectors saw significant multiple expansion in following a very tough With fundamentals intact in large cap biotech, we think that multiple stabilization is likely in and that there is still potential for multiple expansion in the group.

We recently hosted a conference call with senior leadership from the Biotechnology Industry Organization BIO to discuss the key public affairs points that impact the industry. Overall, the emerging legislation appears fairly benign relative to initial fears, in our view. The provision for marketing exclusivity for biologic drugs now sits at 12 years in the House and Senate bills.

BIO stated that there are hundreds of amendments that have been proposed that reduce the exclusivity, so until a bill is passed, there will be uncertainty around the length of exclusivity.

Further, interchangeability of biosimilars is not currently on the table. In our view, the final provisions around biosimilars bear watching in the signed bill but in their current form would represent a better outcome than expected in past years.

Several members of Congress have stated that elimination of the Medicare Part D donut hole is a high priority. The gap is expected to be gradually phased out over 10 years. Coverage of donut hole costs would have the greatest impact on higher-priced oral medications. But pricing could come under some pressure, which would be offset by monies paid to copay foundations. According to BIO, there are provisions originating from the Senate Finance Committee that made it into the final Senate bill regarding comparative effectiveness measures.

The key point is that the bill provides for comparative effectiveness research to be conducted by an independent agency to inform clinical decisions. Findings would be disseminated to the clinical community for the purpose of improving decision-making but would not be used to direct coverage or reimbursement policy through any sort of governmental agency. Another policy drift that bears watching is whether CMS will force restricted utilization of erthropoiesis stimulating agents ESAs in renal indications.

In Summary, We See Sector Rerating Potential in Considering the healthcare sector trading trends, we believe there is potential for biotechs to maintain or perhaps strengthen ownership in , leading to a rerating in the group. We believe that the cyclical trade could run its course in , leading to reassessment of allocations.

The bottoming of sector weighting suggests fund inflows could lead to a neutral weighting. We see a rationale for multiple expansion in large cap biotech, in which, as with its healthcare brethren, a year of contraction is followed by a year of expansion.

See our section below on biotech fundamentals for a detailed discussion of the group multiple. The healthcare reform effort now appears to not only eliminate an overhang but also is actually resolving favorably for the industry, with innovation in biologics protected, industry givebacks limited, and an increased addressable population protecting and building upon industry fundamentals. Biotech Sector Fundamentals in In addition to macro trends impacting the biotech sector, we have examined sector-specific fundamentals as a key to performance in Among these, a clear biotech-specific trend has been steady multiple contraction among the large caps and concerns that this trend could continue going forward.

Historically low valuations, reasonable earnings estimates and low pipeline expectations could act as catalysts for the large cap group, in our view. Among the SMid caps, access to capital should be much easier in but, not surprisingly, the focus will be on clinical catalysts and regulatory events.

This past year, as the market began to recover, the focus shifted from healthcare and biotech, which were in the midst of a heated healthcare reform debate, to early cyclicals and other sectors that were beaten up in Beyond healthcare reform concerns, biotech has faced other fundamental headwinds that have left sentiment still pretty poor in the sector.

Our and EPS estimates do not embed meaningful operating leverage, which should be quite evident as these companies mature, nor do our estimates assume a significant impact from new launches or expanded labels for currently marketed drugs.