The first European exchange traded funds made their debut on the stock markets last month, offering investors a new way to play the booms and busts of equity indices. Run by Barclays Global Investors, the UK's first ETFs called "iShares" track the performance of the FTSE100, and started trading on the London Extramark, the exchange for innovative products, on April 28.

They will compete with "leaders," LDRS (Listed diversified return securities), launched last month. The price of LDRS emulates the movements of pan-European equity benchmark Dow Jones Stoxx 50 and the Dow Jones Euro Stoxx 50.

Traded and settled just like any share in a listed company, the two European EFTs are a stake in a fund whose composition is the exact replica of that of their target index.

However, in practice, they are a cross-market hedge of Europe's leading stocks from all industry sectors. Analysts predict the European market for ETFs is likely to grow as quickly as it has in the US over the past seven years.

"As the equity investment culture in Europe is growing, the demand for ETFs will rise," says John Demaine, managing director of product development at BGI. "ETFs will be popular because they are transparent and easy to buy".

ETFs now represent between 50 per cent and 70 per cent of daily trading volume on the American Stock Exchange, says Deborah Fuhr, vice-president, marketing, at Morgan Stanley International.

organ Stanley Dean Witter is considering the introduction ETFs in Europe. Holding iShares or LDRS allows investors to diversify their assets in times of high market volatility in Europe.




"Holding a diversified portfolio of assets carries less stock-specific risk relative to your benchmark," says Christopher Jackson, director of equity markets at Merrill Lynch, co-lead manager of the LDRS issue with Landesbank Baden-Wurttemberg.

Hedge funds that wish to follow long and short strategies are likely to invest in European ETFs along with pension funds which wish to gain exposure to the indices without having to buy a futures contract - usually forbidden by their investment guidelines.

LDRS, which stand for listed diversified return securities, are currently traded on Deutsche Borse. They will be listed on the Zurich Stock Exchange and the Paris Bourse later this year.

LDRS are issued and managed by the European Exchange Traded Funds Company, created for that purpose. The Bank of New York acts as the shares' custodian and administrator. The bid-offer spread cannot exceed 100 basis points and the fees are capped at 50 basis points.

Initially, the fund underlying the Dow Jones Euro Stoxx 50 is to be for E350m and the fund invested in the Dow Jones Stoxx 50 will be for about E50m.

r Jackson said he expects to see greater demand for ETFs that track the euro-zone index than for those following the pan-European index. The Dow Jones Euro Stoxx 50 has historically performed better than its pan-European brother.

The euro-zone index gained 41.59 per cent last year while the value of its wider counterpart rose by 39.22 per cent during that period. Because the fund is open ended, ETF shares can be redeemed for the underlying equities.

The introduction of ETFs in Europe brings new arbitrage opportunities. Traders can play on the difference in price between the underlying shares included in the fund, the futures contract on the indices and the ETFs themselves.

"This will keep the shares liquid," said Mr Jackson. However, the price between the three assets should converge over time as trading intensifies. LDRS and iShares may prove useful to fund managers who want to invest their excess cash in equities without taking a particular position on the market.

Investment banks are clearly catching up with the US where ETFs have been traded since 1993. The US market is now worth $45bn with a daily turnover of $2bn.

As new indices are created, analysts predict a raft of new products that track their performance will roll out on the market. The latest development in the US has been the introduction in 1998 of Diamond funds based on the Dow Jones Industrial Average.

Other popular products include the Spider or SPDR 500 based on the S&P 500 which has a market capitalisation of about $15bn. These first European ETFs use the same principle as FTSE100 Trains but are more accessible to retail investors than their British peers.

The price of an LDRS is equal to one hundredth of the level of indices which, at its launch last month, was about E50. The value of a FTSE 100 Trains usually hovers around £65,000, a large sum for small private pocket books.


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