Overview of the key characteristics and risks of financial instruments
Risks are inherent in investing in financial instruments and not all financial instruments carry the same risks. It is important that you are aware of the risks before investing with Easyvest. This is the purpose of this document.
Firstly, we describe some general risks associated with financial instruments. Secondly, we review the characteristics and risks of the financial instruments in which Easyvest invests. This overview of the main characteristics and risks of financial instruments is not exhaustive.
Investing requires a dose of common sense. You must set realistic expectations and well-defined investment goals. You must also know how much cash you can do without, how long you can go without it and never take more risks appropriate to your knowledge and experience. By following these principles, you will avoid disappointment and unpleasant financial surprises.
For more information on investment risks, please contact your Easyvest advisor.
The following general risks may exist to a greater or lesser extent for any financial instruments:
When you invest in financial instruments, unpredictable price drops are almost inevitable. However, it is possible to limit this type of risk. One of the most common methods is to spread your investments over several categories of financial instruments and, within each category, over different instruments. This is called diversification.
Market risk is the risk that the entire financial market or one category of assets will decline, with an impact on the price and value of portfolio assets. Such fluctuations may, among other things, result from currency movements or sharp rises or falls in interest rates and/or stock exchange prices generally.
If you invest in a currency other than the euro then the rate for that currency when you sell securities may be different to the rate when you bought it. This can have either a positive or a negative effect on your investments.
Credit risk is the risk that the issuer of a bond-like financial instrument or the debtor will not meet, in part or in full, its obligation to repay the capital or to make the (annual or interim) interest payments. The most common cause of this is the poor financial position or bankruptcy of the issuer.
Liquidity risk occurs when a given investment is difficult to sell. A distinction must be made between illiquidity caused by supply and demand, and illiquidity caused by the nature of the financial instrument or market practice. Illiquidity is caused by supply and demand when there is (almost) exclusively supply (sellers) for a financial instrument at a certain price. The same principle applies when there is (almost) exclusively demand (buyers) for a financial instrument at a certain price. In these circumstances, buy and sell orders cannot be executed or can only be executed in part or at unfavorable conditions.
If the market interest rate rises, the value of certain investments will fall. This is especially the case for bonds, but in theory also for shares. In the case of bonds, a rise in interest rates leads to a fall in prices. This is due to investors asking for compensation in return of higher interest rate. Given that the interest rate is fixed when the bond is issued for its entire duration, this compensation can only be provided by lowering the price. The fixed interest payment provides a higher yield for the buyer of the bond when the purchase price is lower. Falling interest rates have the opposite effect: the price of your bonds will rise, assuming that all other factors affecting the bond are equal.
This refers to the risk that you will not be able to reinvest the interest paid, the dividend issued, investments you have sold or other investment income on the same terms as the original investment.
Fiscal risk occurs where legislation is ambiguous or likely to change in respect of the fiscal aspects or tax treatment of financial instruments. For overseas financial products, fiscal agreements between governments can affect returns. Similarly, changes in your personal circumstances, such as divorce, a death, or a change to your residence may also result in the application of different tax rules to your investments. Moreover, if you make profits outside of your professional activities from transactions or speculation outside the scope of a normal management of private wealth, the increase in value in your portfolio may be subject to tax.
This risk is linked to changes in the economic situation. Think of times of economic recession, of largescale social changes, or of dwindling worldwide commodity reserves. These changes have an impact on the price levels of financial instruments.
When you buy a share in a company, as a shareholder you become a owner of a part of that company. As a shareholder, you agree to take risks. You can enjoy of share of the company's profits when things are going well, but equally, you will share in potential losses the company suffers if things are go less well. You may even lose your entire investment if the company goes bankrupt. Bond investments are not exempt from the risk of bankruptcy either. Although bondholders are repaid before shareholders, if the failing company does not have the funds to repay, the bond investor may also lose all or part of his or her investment.
Inflation means an increase in the general level of prices of consumer goods, resulting in a decrease in the (intrinsic) value of money and the purchasing power of money. Inflation brings with it the chance of a fall in the real value of your investment portfolio even if the (nominal) return continues to look respectable. To calculate the real situation, you therefore need to deduct the inflation rate from the value of your investments.
A country or region may become so economically or politically unstable to the point where no currency is available or the entire payment system comes to a halt. In this case, an otherwise solvent foreign debtor may no longer be able to meet its commitments. If financial products are issued in a foreign currency, you as an investor also run the risk of receiving payments in a currency that is no longer convertible due to exchange restrictions.
In the context of the implementation of the European Directive on Markets in Financial Instruments (MiFID) into Belgian law, Easyvest distinguishes between complex and non-complex financial instruments. Shares and funds listed on a regulated market or on a market considered as equivalent to a regulated market, trackers listed on the regulated segment of Euronext, ordinary bonds and unlisted funds benefiting from the European passport (UCITS funds) are regarded by Easyvest as non-complex financial instruments. Shares and funds listed on a non-regulated market, on a market considered as equivalent to a non-regulated market (such as the OTCBB market), or on an MTF3 , ETFs listed on the MTF segments of Euronext and markets other than Euronext, ETNs, ETCs, complex bonds, unlisted funds not benefiting from the European passport (non-UCITS funds), turbos, sprinters, warrants, options, forex, futures, CFDs and structured products are regarded by Easyvest as complex financial instruments.
Although the outlook for a company may objectively appear to be good, rumors, opinions, trends or other unpredictable factors can have a major influence on the share price of a company, due to the irrational behavior of other investors, or your own actions.
Every IT system has its own interface, with a specific terminology and methodology for executing financial transactions. Therefore, a certain term in a certain language in a certain system may have a different meaning in another language or system. Problems may therefore occur when placing orders.
In this chapter, we describe the characteristics and risks relating to the financial instruments in which Easyvest may invest as part of its portfolio management service, namely trackers, and the financial instruments that make up these trackers.
A tracker is an investment product listed on an exchange that tracks the performance of a basket of assets. There are different types of trackers: stock exchange index trackers, sector trackers, commodity trackers, bond-index trackers, etc. They can be traded on any trading day like shares.
A tracker can take the following legal forms: as a fund ("Exchange Traded Fund" or ETF), or in the form of a debt instrument, including trackers on commodities such as energy, oil or metals ("Exchange Traded Notes" or ETN, and "Exchange Traded Commodities" or ETC).
Within the trackers mentioned above, Easyvest only invests in ETFs trackers.
Exchange Traded Funds or ETFs trackers are open-ended funds that replicate a benchmark index as closely as possible (also known as passive ETFs). ETFs trackers generally comply with the UCITS Directive. Like funds, ETFs trackers can be set up as an investment company or a mutual fund.Note: Alongside traditional ETFs that seek to replicate an index as closely as possible, active ETFs have emerged. These instruments seek to outperform a benchmark. However, outperformance is not a guarantee. Some ETFs can beat their index, but they cannot do much worse. By definition, active ETFs are not trackers.
Given that by investing in an ETF tracker you are investing in a basket of assets, this can involve less risk than investing in individual financial instruments. The principle of an ETF tracker contrasts sharply with actively managed funds, where the manager constantly tries to select the best stocks in order to achieve the highest possible yield. That is very cost and time intensive. Therefore, the management fees are generally quite a bit lower for ETF tracker than for traditional funds.
Some ETFs trackers can multiply the performance of the index (leverage) or track the reverser of the index-movements (a so-called bear tracker) with or without leverage. This obviously involves more risks.
The price of an ETF tracker is mainly determined by the evolution of the underlying index. If the index increases, the value of the ETF tracker will also increase. However, the price of the ETF tracker does not necessarily have to be the same as the level of the index. This is because the accumulated dividend and the management costs applied are also included in the calculation of the ETF's trackers price. In addition, the buy and sell orders on the stock exchange also determine the price. The more a specific ETF tracker is traded, the smaller the spread between the bid and offer prices will be, and the closer the price will stay to the price of the index.
In order to achieve their investment objectives, ETFs trackers issuers seek to physically or synthetically replicate the index in question.
Physical replication can be achieved by fully replicating the underlying index (the ETF tracker invests in all the index components) or by using a process known as ‘optimization’. This is done when the underlying index consists of a very large number of constituents, or includes securities that are difficult to trade, or if multiple indices are being tracked. In this case, the ETF tracker issuer will invest only in a basket of constituents that provides a representative sample in terms of risk and performance. Therefore, an ETF tracker does not always include exactly the same financial instruments as the index that is being tracked.
An ETF tracker may also synthetically reproduce the returns on its underlying index. When this occurs, the ETF tracker issuer agrees one or more swap(s) with one or more counterparties. The ETF tracker issuer agrees to pay the swap issuer the returns on a pre-defined basket of securities, in exchange for the return on the index. You then are paid out the return on the whole underlying index, but the actual investment might be made in quite different securities. This technique is called synthetic replication. This type of replication generally reduces the costs and the tracking error (deviation from the index), but increases the counterparty risk. For markets that are not easily accessible, swap structures are preferable to physical replication.
| Risk | Is present |
|---|---|
|
Price risk |
Yes, mainly depending on the general development of the stock market and the underlying investments |
|
Exchange rate risk |
Yes, if the underlying investments or the tracker are not listed in euros |
|
Credit risk |
Yes, especially for bond-index trackers |
|
Liquidity risk |
Yes, depending on the tracker’s trading volume and the liquidity of the underlying investments |
|
Interest rate risk |
Yes, for bond-index trackers and indirectly for share-index trackers |
|
Reinvestment risk |
Yes |
|
Tax risk |
Yes |
|
Market risk |
Yes |
|
Inflation risk |
Yes |
|
Geographical risks |
Yes, depending on the tracker |
|
Complexity risk (MiFID) |
No |
The price of an ETF tracker may deviate from the index being tracked due to volatility or a lack of liquidity.
A counterparty risk exists if the ETF tracker also buys derivatives or enters into contracts with other parties (swaps). This is especially the case for ETFs that use synthetic replication. Counterparty risk is the risk that one party will not be able to meet his commitments (e.g. the failure to return securities on loan). In the case of UCITS-compliant synthetic ETFs trackers, the counterparty risk may not exceed 10% of the net asset value of the fund.
A share is a title of ownership that represents a portion of the subscribed capital of a company. By purchasing a share, you become a owner of a piece of the company in question. This means that the return on your investment will depend on the success (or failure) of that company’s business.
If the company is in good health and its operations generate profits, then you share in the price rise and possibly in dividend payments. However, if the company runs into financial difficulties and market participants believe that the company will struggle to generate a profit in the future, then the price will fall and you may receive reduced dividends or none. In the event of bankruptcy, the value of the shares may fall to zero.
The price of a share depends on both internal and external factors:
Internal factors: actual or expected company results, news about the company and/or sector, dividend policy, etc. ;
External factors: political events, macroeconomic developments, irrational factors that may exacerbate stock market fluctuations (such as rumors and speculation).
As a shareholder, you have, among other things, the right to vote at the general meeting (except in the case of non-voting shares) and the right to a part of the business’ liquidation value if the company is dissolved (as long as there is a liquidation balance).
Shares may be registered by name or dematerialized.
Registered shares are characterized by being included in the register of shareholders of a company, in the name of the shareholder. The transfer to third parties is carried out by an entry of the transfer in the register recording the transfer of ownership. This type of transfer is relatively unusual.
Dematerialized shares are represented by an entry in a share account in the name of the shareholder at an institution authorized for this purpose. You can generally sell these easily at any time, on any day. This is even easier for shares in exchange-listed companies.
Share certificates are securities that represent original shares and are managed by a trust company. The certificate tracks the value (price) of the underlying share and provides the same yield (dividend). The main difference with a share is that a certificate does not give the right to vote at the shareholders' meeting.
The risks are in principle the same as for ordinary shares.
| Risk | Is present |
|---|---|
|
Price risk |
Yes. This is determined by both the company's policy and the macro-economic, micro-economic, and financial context. Favorable or unfavorable market conditions may affect the instrument |
|
Foreign exchange risk |
Yes, if the share is not listed in euros or if the company does its business outside of the Eurozone |
|
Credit risk |
No, shares are risk-bearing capital and not debts. Of course, shares can lose some or all of their value in the event of bankruptcy |
|
Liquidity risk |
Yes, depending on the volume of transactions in the share and the free float. The larger the company's market capitalization, the more liquid the market for its shares |
|
Interest rate risk |
Yes, depending on the stocks and the investment climate. Generally, a rise in interest rates has a negative influence on share prices |
|
Risque de réinvestissement |
Yes |
|
Risque fiscal |
Yes |
|
Risque de marché |
Yes |
|
Risque d’inflation |
Yes |
|
Risques géographiques |
Yes |
|
Risque de complexité |
No |
As a co-owner of a company, you run the same risks as any entrepreneur: when times are bad, you share in the losses. You can even lose up to 100% of your investment if the company goes bankrupt.
There are no guarantees around dividend distribution. In case of low profits or losses, the dividend may be reduced or even cancelled. On the other hand, some companies have a policy of never paying a dividend.
A bond is a negotiable instrument representing a debt issued by governments (government bonds), supranational bodies (supranational bonds) or companies (corporate bonds). As a bondholder, you have a certificate of participation in a long-term loan (> 1 year) for which you normally receive periodic interest payments (coupons).
A bond is always issued on the primary market. This is the market where new bonds are issued. You can only subscribe a bond during the subscription period.
A bond may be issued at par (100% of the face value), or higher or lower to adjust the return to match market conditions. If you want to buy a bond after the subscription period, you have to to go to the secondary market, where these securities are freely traded. Their liquidity depends, among other things, on the size of the issue and on the issuer. The price of transactions depends on interest rates movements (the price is basically below the issue price if interest rates have risen since the issue date and above it in the opposite case), and on any changes in the solvency of the issuer since the issue date.
On the final maturity date, the bond is repaid at the price fixed in advance, usually at par (100% of the face value). Some bonds may be redeemed earlier, usually at the initiative of the issuer.
There are several forms of bonds: government bonds, supranational bonds, domestic corporate bonds, subordinated bonds, Eurobonds, (reverse) convertible bonds, floating rate bonds, perpetual bonds. As Easyvest does not invest directly in bonds, there is no need to describe them separately in more details.
| Risk | Is present |
|---|---|
|
Price risk |
Yes, in case of sale before maturity and in case of deterioration of the financial situation of the issuer. For convertible bonds, in case of sale before maturity and after conversion. For perpetuals, the price is sensitive to the evolution of the bond market because of the indefinite duration |
|
Exchange rate risk |
Yes, if the bond is not denominated in euros |
|
Credit risk |
Yes, depending on the quality of the issuer (rating). Subordinated debt involves higher risk |
|
Liquidity risk |
Yes, depending on the issue size, the transactions, the issuer type, and the currency |
|
Interest rate risk |
Yes, depending on the time remaining until maturity. The longer the time remaining until maturity, the greater the risk that interest rates will rise and the bond’s value will fall |
|
Reinvestment risk |
Yes |
|
Tax risk |
Yes |
|
Market risk |
Yes |
|
Inflation risk |
Yes |
|
Geographical risks |
Yes |
|
Risk of complexity |
No |
The issuer may be temporarily or permanently insolvent and no longer be able to pay interest or repay the loan, for example, due to a general downward trend in the economy, or to political events. If the bonds are listed on the stock exchange, this may also have a negative impact on their price movement.
This risk is almost non-existent for government bonds issued by OECD countries (state guarantee), for bonds issued by supranational institutions and generally also for issuers with an investment grade rating (at least BBB). For non-investment grade bonds, the risk of insolvency of the debtor and therefore the risk of non-payment is higher.
In some cases, the issuer may proceed to early redemption of a loan. For example, if interest rates fall. This may have an adverse effect on yields.
Convertible bonds are, like ordinary bonds, exposed to credit risk. But this risk is higher because convertible bonds are often subordinated to ordinary bonds.