Proceedings

involves smaller capital allocations than in the case of a core portfolio that has a
higher risk but also a superior profitability than the market’s profitability.
The correlation between the profitability and risk of financial instruments, the
estimation of future trends, the costs and benefits associated to the holding of certain
assets but also the distinctive characteristics of each particular instrument are the
object of interest of all entities on the capital market.
A comparative analyze of the ETFs and main derivatives instruments that are the main
competitors (Futures on index, swaps on index and options on index) becomes
pertinent. The main differences between these regard explicit costs (commissions and
other taxes), implicit costs (harder to measure – impact of the market, opportunity
costs, expected tracking error), liquidity, operational complexity (documenting,
supervision etc), the risk of counterparty but also the regulated constraints (limitation
of the exposure on certain assets). Also, in choosing the optimum instrument, we have
to take into account the transaction period, the strategy applied by the portfolio
manager as well as the conditions imposed by the client.
Even if they are competitors, the financial innovation phenomenon allowed the
diversification of financial products and gave birth to some very attractive and
complex combinations like the ETFs on futures or the futures on ETFs, having as a
result the harmonization of the used instruments’ characteristics.
Another rival product is the swap on index that, as the ETFs, is attractive for the
portfolio managers and the institutional investors as it offers the possibility of
diversifying the portfolios. The swap on indexes is a contractual financial agreement
that generates a transaction between two parts, where at least one of them is willing to
pay the other a rate of profitability based on stock exchange indexes, at a future
moment, until the end of the contract. The other part is going to make payments based
on a fix or variable interest applied on the same percentage of the capital value that is
at the basis of the swap. Similar to the ETFs and futures contracts, swaps are used in
strategies of asset allocation, their number increasing significantly between 2006-
2008, from 475 billion $ to 1,475 trillions $ in 2008, before Lehman Brothers went
bankrupt. Unlike the ETFs, swaps (agreements between the parts implicated in the
transaction to exchange between themselves the financial advantages they have on
different markets) are not negotiated on a regulated stock exchange market, being
transactions between dealers. Beside the absence of a secondary market, another
disadvantage is the lack of a centralized discounting system, the obligation of a
thorough documentation and of an administrative support and implicates the
possibility of counterparty risk as there is no warranty that the parts are going to fulfill
their obligations.
Another instrument that offers exposure either on the entire market or on specific
segments through a single transaction is the option contract on indexes. This is a
standardized engagement that ensures the right of the buyer, but not the obligation, to
buy or sell a specified quantity of a support asset, at an established price, in exchange
of the payment of a bonus paid to the seller of the option through a compensation
house.
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