Some Germans Stock Up on Index Certificates, While Others Head for ETFs By Aviya Kushner October 18, 2001

In the last year, when ETFs came to Germany, for us it didn't make sense to have index certificates. ETFs are better because there's more liquidity, a much smaller spread, and they're tradeable every day. There are arbitragers who play ETFs against futures, so you can go long and short against ETFs.
- Bernhard Weidner, head of equity financing sales in Germany for BNP.

They're very, very popular (index certificates).
-Vladislav Vassiliev, vice president of global equity derivatives at Deutsche Bank.

Battered NASDAQ stocks and forecasts of sinking world economies are sending some German investors and their European neighbors on a search for an easy-to-understand investment that's less risky than a single stock.

Increasingly, those on the hunt for something comprehensible are turning toward index certificates. The attractiveness of these certificates is that if the stock or bond index rises, the investor benefits by the percentage of the increase. If the index in question falls, the investor does not lose the minimum investment, though any profit can be lost.

"They're very, very popular," says Vladislav Vassiliev, vice president of global equity derivatives at Deutsche Bank.

In fact, index certificates have been such big sellers with DB customers that the bank has created new products based on new indexes - created by the bank -- to help meet demand.

"We issue various kinds of certificates linked to the indexes," says Vassiliev. "The standard indexes like the S&P and the Nikkei, and also proprietary indexes we develop in-house that are designed to outperform the market."

With any index certificate, the major risk for investors is losing out on huge gains if the stock index shoots up. In that case, those who directly own rising stocks in such a market would realize the biggest gains. Of course, the big benefit of a certificate is the relative security of the initial investment. If the index slides, you'll get your initial investment back, usually at the end of the term you agreed to. Deutsche Bank's certificates are also traded on the secondary market - the Frankfurt Stock Exchange - so you can buy or sell the certificates at any time.

As for a currency risk, "the currency hedge is done on the index level," says Vassiliev. "This means that the client doesn't take any view on the currency. He doesn't benefit or lose."

Still, for European investors, the main draw is not the tenuous promise of relative safety, but the clarity of the certificate concept. "They are quite simple, and are traded like a stock or a bond," says Vassiliev. "Clients can see the information. They have a transparent investment concept."

This clarity is leading DB to post numbers like 1.8 billion Euros in sales for the HedgeLink certificate, issued last year. Both private banking and retail clients tend to like the certificate product line.

Declining stock values and decreasing interest rates are making the certificates more popular, bankers in Deutsche Bank's private banking department said.

Index Certificates vs. ETFs

Meanwhile, other major German players are openly snubbing index certificates for ETFs. At BNP, the decision was made to select ETFs over index certificates, despite the competition's certificate success.

"We've seen that the major banks - Commerzbank and DeutscheBank offer certificates, and I think they've had good figures and good interest," says Bernhard Weidner, head of equity financing sales in Germany for BNP.

"In the last year, when ETFs came to Germany, for us it didn't make sense to have index certificates," Weidner said. "ETFs are better because there's more liquidity, a much smaller spread, and they're tradeable every day. There are arbitragers who play ETFs against futures, so you can go long and short against ETFs."

Weidner says investors don't lose out on safety. "You don't have a credit risk for anything," he says. "They are safe."

BNP does offer "theme" certificates, like technology certificates or aging-population product certificates, but it currently does not offer index certificates.

Index Certificates Get More and More Exotic

Encouraged by its sales success, Deutsche Bank is rolling out more new index-certificate products. Late last month, it introduced a new XAVEX Yield Leader Certificate that invests in emerging market bonds. Investors are registered in the EMLE, which is Deutsche Bank's own Emerging Market Liquid Eurobond index. The index includes 21 bonds, and it has less weight in Latin America. For example, 24 percent of its weighting in Argentina and Brazil, compared with 45 percent in JP Morgan's emerging-markets index.

The certificates, which are rated 4 of 5 in terms of risk, with 5 being the highest-risk certificate at DB. Small investors, with a minimum 10,000 Euro investment, can access emerging markets and achieve greater tax efficiency through the new DB product, which has a management fee of 1.75%.

Usually, emerging-market Euroloan investments start at a one million Euro minimum. This new product lets the small investor in, making it a first.

"As far as I know, this is the first investable index with emerging market bonds underlying it for European investors," says Vassiliev.

Still, these are emerging markets securities and caution should be exercised. "We recommend that investors allocate no more than 10% of their total portfolio assets to these certificates," says a DB banker in the Frankfurt private banking department.

Safe, or Just Safer?

In the U.S., the main promoters of index certificates are credit unions. Interestingly, American credit unions tend to promote index certificates as a "safe" alternative to the zigzags of the stock market. European bankers interviewed in Frankfurt and London, however, emphasized that they don't call these certificates "safe" when advising clients.

"When the index certificate business started, the main reason to buy them was if an investor didn't know what stocks to invest in," Vassiliev says. "You basically have four options - direct stocks, equity funds, futures market, and an index certificate."

"A certificate is simpler and more transparent," Vassiliev says. For a novice, a certificate is probably safer than an individual stock pick. But a certificate is just not risk-free, he emphasizes.

Still, it looks like some German investors would rather trade a good night's sleep for dreams of instant wealth from a soaring stock market - if and when it soars again.

For the German speakers who frequent the site, this article can also be found in your native tongue. For the German-language version of IndexFunds.com, please go to http://de.indexfunds.com/. There you'll find the only source for complete index funds data in Europe as well as a lively discussion board. The same article and many more can also be found on the French-language version of the site.