Risk warnings

STATUS: February 2024

I. Introduction

An investment generally involves the use of funds in participations, tangible assets, or similar, with the aim of generating profit. In the present case, it concerns investment in securities in particular. Risks are an inherent part of every investment. Every investor should therefore develop a basic understanding of the essential characteristics, the functioning, and the risks of an investment. The aim of the following explanations is to provide investors with such an understanding.

1. Objective of Investment

The objective of investment is the preservation or increase of wealth. The key difference between investing in securities and savings products like savings books, call money accounts, or savings accounts is the deliberate acceptance of risks in order to pursue return opportunities. With savings products, on the other hand, the deposited amount (nominal value) is guaranteed, but the return is limited to the agreed interest rate.

Traditional saving is one of the most popular forms of investment in Germany. Here, wealth is mainly built up nominally, i.e., through regular deposits and interest income. The saved amount is not subject to fluctuations. However, this supposed security may only exist in the short or medium term. Wealth can be gradually eroded by inflation. If the savings interest rate is lower than the inflation rate, investors must accept a loss of purchasing power and thus a financial loss. The longer the investment period, the stronger the negative impact of inflation on wealth.

Investment in securities aims to protect against this gradual loss of wealth by achieving a return above the inflation level. However, investors must be willing to bear the various risks associated with investment.

2. Interplay of Return, Security, and Liquidity

To select an investment strategy and the corresponding investment instruments, it is important to be aware of the significance of the three pillars of investment, namely return, security, and liquidity:

Return is the measure of the economic success of an investment, measured in profits or losses. This includes, among other things, positive price developments and distributions such as dividends or interest payments.
Security is aimed at preserving the invested capital. The security of an investment depends on the risks to which it is subject.
Liquidity describes the availability of the invested capital, i.e., the timeframe within which and the costs at which the invested capital can be sold.

The objectives of return, security, and liquidity interact with each other. An investment with high liquidity and high security generally does not offer high profitability. An investment with high profitability and relatively high security may be characterized by lower liquidity. An investment with high profitability and high liquidity generally has low security.

Investors must weigh these objectives against each other according to their individual preferences as well as their financial and personal circumstances. When making this trade-off, investors should be aware that an investment promising the realization of all three objectives is usually “too good to be true.”

3. Risk Diversification

For investment, it is particularly important not only to know and consider the risks of individual securities or asset classes but also to understand the interplay of the various individual risks within the portfolio context.

Taking the desired return into account, the portfolio risk should be optimally reduced through a suitable combination of investment instruments. This principle, i.e., the reduction of investment risk through appropriate portfolio composition, is referred to as risk spreading or diversification. The principle of diversification follows the maxim of not putting “all your eggs in one basket.” Anyone who spreads their investment across too few assets exposes themselves to unnecessarily high risk. Through suitable diversification, the risk of a portfolio can be reduced not only to the average of the individual risks of the portfolio components but usually even below that. The degree of risk reduction depends on how independently the prices of the portfolio components develop relative to each other.
Correlation expresses the measure of the dependency of the price development of the individual portfolio components on each other. To reduce the overall risk of the portfolio, investors should distribute their funds across investments that exhibit the lowest possible or negative correlation with each other. This can include, among other things, diversifying investments across regions, sectors, and asset classes. In this way, losses in individual investments can be partially offset by gains in other investments.

II. General Risks of Investment

There are general risks associated with investment that are relevant regardless of the respective asset class, the respective type of securities trading, or the respective investment service. Some of these risks are described below.

1. Economic Risk (Business Cycle Risk)

The overall economic development of an economy typically proceeds in wave-like movements, the phases of which can be divided into recovery, boom, downturn, and recession. These economic cycles, and often the associated interventions by governments and central banks, can last several years or decades and have a significant impact on the performance of various asset classes. Unfavorable economic phases can thus negatively affect an investment in the long term.

2. Inflation Risk

Inflation risk describes the danger of suffering a financial loss due to currency devaluation. If inflation – i.e., the positive change in prices for goods and services – is higher than the nominal interest rate of an investment, this results in a loss of purchasing power equal to the difference. This is referred to as negative real interest rates.

The real interest rate can serve as a guide for a possible loss of purchasing power. If the nominal interest rate of an investment over a certain period is 4% and inflation over this period is 2%, the real interest rate is +2% per year. In the case of 5% inflation, the real interest rate would only be -1%, which would correspond to a loss of purchasing power of 1% per year.

3. Country Risk

A state can influence capital movements and the transferability of its currency. If a debtor domiciled in such a state is unable to meet an obligation (on time) for this reason, despite being solvent itself, this is referred to as country or transfer risk. The investor may suffer a financial loss as a result.
Reasons for such influence on capital movements and currency transferability can include, for example, foreign exchange shortages, political and social events such as changes in government, strikes, or foreign policy conflicts.

4. Currency Risk (Foreign Exchange Risk)

For investments in a currency other than the investor’s home currency, the achieved return depends not only on the nominal return of the investment in the foreign currency. It is also influenced by the development of the exchange rate between the foreign currency and the home currency. A financial loss can occur if the foreign currency in which the investment was made depreciates against the home currency. Conversely, a depreciation of the home currency can result in an advantage for the investor. Currency risk exists not only for cash deposits in foreign currencies but also for investments in shares, bonds, and other financial products denominated or paying distributions in a foreign currency.

5. Liquidity Risk

Investments that can usually be bought and sold quickly and whose bid and ask prices are close together are described as liquid. For these investments, there is generally a sufficient number of buyers and sellers to ensure continuous and smooth trading. For illiquid investments, or during market phases with insufficient liquidity, it is not guaranteed that an investment can be sold quickly and without significant price discounts. This can lead to financial losses if, for example, an investment can only be sold at a loss.

6. Volatility

The value of an investment can fluctuate over time. This applies particularly to the prices of securities. So-called volatility is a measure of these fluctuations within a certain period. The higher the volatility of an investment, the stronger these fluctuations in value (both upwards and downwards). A longer-term investment in the capital market counteracts short-term fluctuations in that short-term value swings become less relevant over a longer period.

7. Cost Risk

Costs are often neglected as a risk factor in investment. However, explicit and hidden costs are crucial for investment success. For long-term investment success, it is essential to pay close attention to the costs of an investment.

Credit institutions and other financial or investment service providers generally pass on transaction costs for the purchase and sale of securities to their customers and may additionally charge a commission for executing the order. Furthermore, banks, fund providers, or other financial service providers or intermediaries usually charge so-called ongoing costs, such as custody account fees, management fees, front-end loads, or pay commissions, which are not readily apparent to the customer. These incurred costs should be included in the overall economic assessment: the higher the costs, the lower the effectively achievable return for the investor.

8. Tax Risks

Income generated from investments is generally subject to taxes and/or levies for the investor. Changes in the tax framework for capital gains can lead to a change in the tax and levy burden. For investments abroad, double taxation may also occur. Taxes and levies thus reduce the effectively achievable return for the investor. Furthermore, tax policy decisions can have a positive or negative impact on the price development of the capital markets as a whole. Investors should, if necessary, contact their competent tax authority or their tax advisor to clarify tax issues and mitigate the associated risks.

9. Risk of Credit-Financed Investments (Leveraged Investments)

Investors may, under certain circumstances, obtain additional funds for investment by taking out loans or leveraging their securities, with the aim of increasing the investment amount. This procedure creates a leverage effect on the capital employed and can lead to a significant increase in risk. In the event of a falling portfolio value, margin calls on the leverage or interest and principal payments on the loan may no longer be serviceable, forcing the investor to (partially) sell the portfolio. Retail investors are therefore generally advised against credit-financed investments. Retail investors should generally only use freely available capital for investment, which is not needed for current living expenses and covering current liabilities.

10. Risk of Incorrect Information

Accurate information forms the basis for successful investment decisions. Incorrect decisions can be made due to missing, incomplete, or false information, as well as incorrect or delayed information transmission. For this reason, it may be appropriate under certain circumstances not to rely on a single source of information but to seek further information. Examples include the key information documents, key investor information, and other sales documents provided by the provider of the financial instrument.

11. Risk from Trading Halts and Disruptions

Trading in financial instruments may be interrupted temporarily, for example, due to technical disruptions or by the execution venue, or may be temporarily unavailable for other reasons. Particularly with volatile investments, investors may consequently be unable to sell the investment. Losses may occur during this time.

12. Risk of Self-Custody

Self-custody of securities exposes the investor to the risk of losing the physical certificates. Replacing the security certificates embodying the investor’s rights can be time-consuming and costly. Self-custodians also risk missing important deadlines and dates, meaning certain rights may only be asserted late or not at all.

13. Risk of Custody Abroad

Securities acquired abroad are usually held in custody by a third party located abroad, selected by the custodian bank. This can lead to increased costs, longer delivery times, and uncertainties regarding foreign legal systems. Particularly in the event of insolvency proceedings or other enforcement measures against the foreign custodian, access to the securities may be restricted or even impossible.

III. Functioning and Risks of Various Asset Classes

1. Call Money and Savings Interest

1.1 General

The acceptance of third-party funds as deposits or other unconditionally repayable funds from the public is referred to as the deposit business. Legally, this is regularly treated as a loan. A distinction is usually made between call money (demand deposit) and fixed-term savings offers. Deposits in a call money account earn interest at a variable rate with no fixed term. The deposit is available daily. A fixed-term savings account, however, has a fixed term during which the investor cannot access the deposit (or possibly only by forfeiting the agreed interest).

1.2. Specific Risks

Inflation Risk: Inflation risk refers to the change in the purchasing power of the final repayment and/or the interest income from an investment. If inflation changes during the term of a deposit such that it exceeds the deposit’s interest rate, the investor’s effective purchasing power decreases (negative real interest rates).
Default Risk: There is a risk that the deposit-holding credit institution may fail (e.g., in case of insolvency), meaning it can no longer service the repayment of savings deposits. This risk can be mitigated by so-called deposit guarantee schemes, which ensure the repayment of the savings deposit partially or fully. In Europe, for example, all EU member states have agreed to establish national deposit guarantee schemes according to harmonized European guidelines. EEA countries that are not EU members (e.g., Norway) have also established deposit guarantee schemes. These schemes intervene up to a certain guarantee amount (generally up to EUR 100,000 in the EU) if a bank is unable to repay its customers’ deposits.
Interest Rate Risk: Call money deposits are subject to the risk of changes in the applicable interest rate by the deposit-holding credit institution.
Foreign Currency Risks: If call money or fixed-term savings are held in a currency other than the investor’s home currency, the development of the exchange rate between the foreign currency and the home currency also influences the success of the investment. Furthermore, country risks exist in the form of influence on capital movements and currency transferability.

2. Shares (Stocks/Equities)

2.1. General

Shares are securities issued by companies to raise equity capital, representing a share right in the company. The shareholder is thus not a creditor, as with a bond, but a co-owner of the company. The shareholder participates in the economic success and failure and benefits through profit distributions, known as dividends, and through the share price performance.

For shares with a par value (Nennwertaktien), the extent of the participation in the company represented by the share results from the specified fixed monetary amount. A no-par value share (Stückaktie) represents a certain number of shares. The participation quota of the individual shareholder, and thus the extent of their rights, results from the ratio of the number of shares they hold to the total number of shares issued.

There are different types of shares equipped with different rights. The most important types are common shares (Stammaktien), preferred shares (Vorzugsaktien), bearer shares (Inhaberaktien), and registered shares (Namensaktien). Common shares carry voting rights and are the most common type of share in Germany. In contrast, preferred shares do not carry voting rights. As compensation, the shareholder receives preferential treatment, e.g., in the distribution of dividends. With a bearer share, registration of the shareholder in a share register is not necessary. The shareholder can exercise their rights without registration. Bearer shares are therefore more easily transferable, which typically improves tradability. With a registered share, the name of the owner is entered into a share register. Without registration, the rights arising from owning the share cannot be asserted. Registered shares whose transfer to a new shareholder is additionally subject to the company’s approval are called registered shares with restricted transferability (vinkulierte Namensaktien). For the issuing company, registered shares with restricted transferability are advantageous in that they maintain an overview of the circle of shareholders. However, registered shares with restricted transferability are not common in Germany.
Participation in a stock corporation (Aktiengesellschaft) grants the shareholder various rights. Shareholder rights in Germany arise from the German Stock Corporation Act (Aktiengesetz) and the articles of association of the respective company. These are essentially property rights and administrative rights.

Regarding property rights, the claim to dividends, subscription rights, and the claim to bonus or scrip shares are particularly noteworthy:

Dividend: The annual profit distribution by the issuer to the shareholders. This depends on the economic development of the company, especially the distributable profit. A decision on the dividend amount is made by the shareholders at the general meeting as part of the appropriation of profits.
Subscription Right: The right of the shareholder to participate in a capital increase to maintain existing voting rights ratios and compensate for a possible financial disadvantage. A specific period must be observed for exercising the subscription right (which, incidentally, is independently tradable during this time).
Bonus or Scrip Shares: An issue of bonus or scrip shares can occur as part of a capital increase from company reserves. In such a case, the company increases its share capital from its own reserves without external contributions. The value of the company (unlike the number of shares) does not increase as a result.

Regarding administrative rights, the right to attend the general meeting, the right to information, and the voting right are particularly noteworthy. These administrative rights are legally mandated and enable the shareholder to pursue their interests. The general meeting usually takes place annually. Resolutions on agenda items are passed by the shareholders at this meeting. Items subject to resolution are cases provided for by law or the articles of association (e.g., the use of distributable profit, amendments to the articles of association, or the discharge of the management board and supervisory board). At the general meeting, the shareholder has a right to information on legal and business matters. Only in exceptional cases does the management board have the right to refuse information. The shareholder’s voting right is the most important administrative right. As a rule, each share is assigned one vote. An exception is preferred shares. The holder of these has no voting rights but is given preference in the distribution of distributable profit. Voting rights can be exercised either personally by attending the general meeting or transferred to a third party by proxy.

A special feature in the area of real estate investment is REITs (Real Estate Investment Trusts). These are regularly stock-exchange listed corporations whose business consists of acquiring, constructing, letting, leasing, and selling real estate. In addition to the risks inherent in an investment in shares, there are therefore specific risks associated with the real estate asset class. While REITs in Germany have the legal form of a stock corporation, other structures are possible for foreign REITs. For REITs, the majority of assets must consist of real estate, and furthermore, the majority of the distributable profit must be distributed to the shareholders. If certain conditions are met, REITs are tax-advantaged, as income is taxed at the shareholder level rather than at the company level. If REITs are listed on a stock exchange, as required in Germany, their value is determined by supply and demand.

2.2. Specific Risks

Price Risk: Shares can be traded both on stock exchanges and over-the-counter. The price of a share is determined by supply and demand. There is no calculation formula for the “correct” or “fair” price of a share. Models for share price calculation are always subject to subjective assumptions. Price formation depends heavily on the different interpretations of accessible information by market participants. Numerous empirical studies show that share prices cannot be systematically predicted. Share prices are influenced by many factors. The associated risk of negative price development can be roughly divided into company-specific risk and general market risk. Company-specific risk depends on the economic development of the company. If the company performs worse economically than expected, negative share price developments can occur. In the worst case, namely insolvency and subsequent bankruptcy of the company, the investor can suffer a total loss of their invested capital. However, the price of a share can also move due to changes in the overall market, without company-specific circumstances underlying this price change. Price changes that arise more due to general trends in the stock market and are independent of the economic situation of the individual company are referred to as general market risk.
Insolvency Risk: Since shareholders are served in insolvency only after all other creditor claims have been met, shares are considered a relatively high-risk asset class.
Dividend Risk: The shareholder’s participation in the company’s profit through monetary distributions is called a dividend. Just like the future profits of a company, future dividends cannot be predicted. If a company earns less than planned profit or no profit at all and has not built up any reserves, the dividend may be reduced or suspended entirely. However, even if a profit is made, a shareholder has no right to a distribution. If provisions are deemed necessary by the company, e.g., due to expected future costs (lawsuits, restructuring, etc.), it may suspend the dividend despite having made a profit.
Interest Rate Risk: In the course of rising interest rates, share prices may decline, for example, because the company’s borrowing costs may increase, or future profits are discounted at a higher interest rate and thus valued lower today.
Liquidity Risk: Usually, bid and ask prices are continuously quoted for exchange-traded shares, especially for companies with a high market capitalization that are part of a major stock index, such as the DAX. If, for various reasons, tradable prices are not available on the market, the shareholder temporarily has no way to sell their share position, which can negatively impact their investment. An example of illiquid shares is so-called penny stocks. These are characterized by a very low stock exchange price (usually below the equivalent of one US dollar) and are often not traded on a market regulated and supervised by state-recognized bodies. There is a risk here that the security can only be sold again under difficult conditions and with significant price disadvantages (due to a very wide spread between bid and ask prices). Furthermore, with penny stocks, there is also an increased risk of price manipulation by market participants.
Psychology of Market Participants: Besides objective factors (economic data, company data, etc.), psychological factors also play a role in the trading of a security on an organized market, e.g., a stock exchange. Expectations of market participants, who may hold potentially irrational opinions, can contribute to rising or falling prices or decisively reinforce them. Share prices thus also reflect assumptions, moods, hopes, and fears of investors. The stock exchange is also a market of expectations, where behavior does not always have to be rational.
Risk of Loss and Change of Shareholder Rights: The shareholder rights already described (especially property and administrative rights) can be changed or replaced by corporate law measures. Examples include mergers, spin-offs, and changes in legal form. Furthermore, principal shareholders (i.e., shareholders with a corresponding majority) can force the exit of minority shareholders through a so-called “squeeze-out.” Although these receive legally prescribed compensation, they lose all shareholder rights in return and are forced to give up their investment.
Risk of Stock Exchange Delisting: The stock exchange listing of a share significantly increases its free tradability. Stock corporations can have the admission of the shares by the stock exchange revoked (taking into account legal regulations and stock exchange rules). Shareholder rights (especially property and administrative rights) are generally not affected by this, but the liquidity of the investment suffers significantly from such a “delisting.”

3. Bonds (Fixed-Income Securities)

3.1. General

Bonds refer to a wide range of interest-bearing securities (also called fixed-income securities or Rentenpapiere). These include, in addition to “classic” bonds, index-linked bonds, covered bonds (Pfandbriefe), and structured bonds. The basic functioning is common to all bond types. Unlike shares, bonds are issued by companies as well as public institutions and states (so-called issuers). They do not grant the holder an ownership right. By issuing bonds, an issuer raises debt capital. They are therefore also referred to as debt securities (Schuldverschreibungen), whereby the purchaser of the bond becomes a creditor of a monetary claim against the issuer (debtor). Bonds are generally tradable securities with a nominal amount (amount of debt), an interest rate (coupon), and a fixed term (maturity).

As with a loan, the issuer undertakes to pay the investor a corresponding interest rate. Interest payments can occur either at regular intervals during the term or accumulated at the end of the term. At the end of the term, the investor also receives the nominal amount. The level of the interest rate to be paid depends on various factors. The most important parameters for the interest rate level are usually the creditworthiness of the issuer, the term of the bond, the underlying currency, and the general market interest rate level.

Depending on the method of interest payment, bonds can be divided into different groups. If the interest rate is fixed from the outset for the entire term, these are known as “straight bonds.” Bonds where the interest rate is linked to a variable reference rate and whose interest rate can change during the bond’s term are called “floaters” (floating rate notes). A possible company-specific premium or discount to the respective reference interest rate is usually based on the issuer’s credit risk. A higher interest rate generally means higher credit risk. Just like shares, bonds can be traded on stock exchanges or over-the-counter.

The returns that investors can achieve through investments in bonds result from the interest paid on the nominal amount of the bond and from any difference between the purchase and sale price. Empirical studies show that the average returns achieved with bonds over a longer time horizon have historically been higher than those from savings deposits, but lower than those from investments in shares (Source: Siegel, J. (1992). The Equity Premium: Stock and Bond Returns Since 1802. Financial Analysts Journal, 48(1), 28-38+46).

3.2. Specific Risks

Issuer/Credit Risk: An obvious risk when investing in bonds is the default risk of the issuer. If the issuer cannot meet its obligation to the investor, the investor faces a total loss. Unlike an equity investor, a bond investor is generally better positioned in insolvency because they provide debt capital to the issuer and their claim may be (partially) satisfied from any resulting insolvency estate. The creditworthiness of many issuers is assessed at regular intervals by rating agencies and divided into risk classes (so-called ratings). However, ratings should not be understood as a recommendation for an investment decision. Rather, they can be included as information in the corresponding consideration of an investment decision by investors. An issuer with low creditworthiness usually has to pay a higher interest rate as compensation for the credit risk to the buyers of the bonds than an issuer with excellent creditworthiness. For secured bonds (“Covered Bonds”), creditworthiness depends primarily on the scope and quality of the collateral (cover pool) and not exclusively on the issuer’s creditworthiness. Furthermore, the risk of loss also depends on the so-called rank or seniority of the bond. Subordinated bonds carry greater risk, as their creditors are served only after senior creditors in insolvency.
Inflation Risk: Inflation risk refers to the change in the purchasing power of the final repayment and/or the interest income from an investment. If inflation changes during the term of a bond such that it exceeds the bond’s interest rate, the investor’s effective purchasing power decreases (negative real interest rates).
Price Risk: The price of a bond is influenced by various factors. Thus, the price of a bond is also subject to the interplay of supply and demand. In particular, the key interest rate level set by the central bank, for example, has a significant influence on the value of a bond. If the interest rate level rises, for example, the interest payments of a fixed-rate bond become relatively less attractive, and the price of the bond falls. An increase in market interest rates is therefore generally associated with falling prices for bonds. The extent of the reaction to changes in the market interest rate is not always the same. Rather, the “interest rate sensitivity” of a bond depends on its remaining term and the coupon amount. Even if an issuer pays all interest and the nominal amount at the end of the term, a loss can still occur for a bond investor if they sell, for example, before maturity at a price below the issue or purchase price of the bond. The aforementioned credit and inflation risks can also have adverse effects on the bond’s price.

4. Commodities

4.1. General

Investments in commodity products are counted among alternative asset classes. Unlike shares and bonds, commodities, when traded for investment purposes, are usually not physically transferred but traded via derivatives (mostly futures, forwards, or swaps). Derivatives are contracts in which the parties agree to buy or sell a specific good (underlying asset) in the future at a fixed price. Depending on whether the market price of the commodity is above or below the agreed price, the value of the derivative is positive or negative. In most cases, there is no actual delivery of the commodities, but rather a cash settlement based on the difference between the market price and the agreed price. This approach facilitates trading, as challenges such as storage, transport, and insurance of the commodities can be ignored. However, this synthetic way of investing in commodities involves some peculiarities that need to be considered. Commodities offer investors the prospect of returns solely through price gains and provide no distributions.
If an investor wishes to invest in commodities, they can, in addition to a direct investment in the commodity (which is generally unsuitable for retail investors), also buy shares in a commodity fund or a security that tracks the performance of commodities.
Open-ended commodity funds share the essential characteristics, functioning, and risks of open-ended investment funds described elsewhere. Beyond these risks, the specific risks associated with commodity investments also exist. Open-ended commodity funds invest predominantly in commodity stocks (i.e., companies involved in the extraction, processing, and sale of commodities) or derivatives of the corresponding commodity. Open-ended commodity funds usually have active fund management responsible for purchases and sales within the fund. Ongoing fees are charged for this, which can be comparatively high. Passive investment instruments, such as ETFs, are generally cheaper as they merely track a commodity index (consisting of several different commodities).
If the investor wants to invest in only one commodity, they must buy a corresponding security that tracks the performance of this commodity (Exchange Traded Commodities, ETCs). ETCs are traded on the stock exchange like ETFs. However, an important difference must be noted: The capital invested in an ETC is not a separate pool of assets (Sondervermögen) protected in the event of the issuer’s insolvency. An ETC is a debt security of the ETC issuer. Compared to an ETF, the investor thus bears an issuer risk with an ETC. To minimize this risk, issuers use different methods of collateralization. The criteria relevant for selecting an ETF are correspondingly applicable to ETCs (cf. section III.7.5).

4.2. Specific Risks

Price Risk: Generally, investments in commodities are exposed to the same price risks as direct investments in commodities. Special events such as natural disasters, political conflicts, government regulation, or weather fluctuations can influence the availability of commodities and thereby lead to drastic price changes in the underlying asset and potentially also the derivative. This can also lead to a restriction of liquidity and result in falling prices. As a production factor for industry, the demand for certain commodities like metals and energy sources is also significantly dependent on general economic development.
Rollover Loss Risk (Roll Yield Risk): The derivative tracking of a commodity (e.g., via futures) within an ETF or ETC requires (depending on the methodology) the so-called rolling of futures contracts into the next time period. This is necessary because futures contracts have a limited term and must therefore be switched into the next maturing contract before expiry (the contract is “rolled”). This can lead to a peculiarity in connection with so-called contango. “Contango” means that futures contracts with shorter terms trade at a discount to futures contracts with longer terms. This can occur, for example, in case of oversupply and lack of demand for the commodity. Rolling the futures contract into the next time period now means that the shorter-term contract must be sold at a lower price, and the longer-term contract must be bought at a higher price. Each roll can lead to a loss in this context, regardless of the general price development of the commodity on the so-called spot market.
Counterparty Risk: Trading via derivatives involves a risk regarding the structure of the derivative contract. If the counterparty is unable or unwilling to meet its obligation under the derivative contract, the derivative contract may not be fulfilled, either wholly or partially.

5. Foreign Currencies

5.1. General

Investments in foreign currencies offer investors an opportunity to diversify their portfolio. Furthermore, investments in the previously mentioned asset classes, among others, are often associated with incurring foreign currency risks. For example, if German investors invest directly or indirectly (e.g., via a fund or ETF) in American stocks, their investment is subject not only to equity risks but also to the exchange rate risk between the Euro and the US Dollar, which can positively or negatively impact the value of the investment.

5.2. Specific Risks

Exchange Rate Risk: Exchange rates of different currencies can change over time, and significant price swings can occur. For example, if German investors invest in US dollars or in a share denominated in US dollars, a depreciation of the US dollar against the Euro (i.e., appreciation of the Euro) adversely affects their investment. Under certain circumstances, even positive share price performance can be offset by the US dollar weakening. Country-specific risks can also influence a currency’s exchange rate. For example, the currencies of oil-exporting countries can depreciate sharply during strong oil price disruptions.
Interest Rate Risk: Changes in interest rates in the home market or the foreign currency market can have significant effects on the exchange rate, as changes in interest rate levels can sometimes trigger large cross-border capital movements.
Regulatory Risks: Central banks play a crucial role in exchange rate formation. Besides money supply and interest rates, some central banks also control exchange rates. They intervene in the markets as soon as certain thresholds are reached by selling or buying their own currency, or they peg the exchange rate wholly or partially to a foreign currency. If these strategies are changed or abandoned, this can lead to significant disruptions in the respective foreign exchange markets. This was observed, for example, when the Swiss National Bank abandoned the minimum exchange rate peg of the Swiss Franc against the Euro at 1.20 EUR/CHF in January 2015, and the exchange rate dropped from 1.20 EUR/CHF to as low as 0.97 EUR/CHF on the same day.

6. Real Estate

6.1. General

This asset class includes residential properties (e.g., apartments and terraced houses), commercial properties (e.g., office buildings or retail spaces), and companies that invest in or manage real estate. Investment can be made either directly by purchasing the properties or indirectly by purchasing shares in real estate funds, Real Estate Investment Trusts (REITs), and other real estate companies.

Open-ended real estate funds share the essential characteristics, functioning, and risks of open-ended investment funds described elsewhere. The key characteristic is that the fund assets are predominantly invested in real estate (such as commercially used land, buildings, own construction projects). Special legal provisions apply to the redemption of fund units. Investors must hold open-ended real estate funds for at least 24 months and announce redemptions with a notice period of 12 months. Furthermore, the investment conditions of open-ended real estate funds may stipulate that fund units can only be returned to the management company on specific dates (at least once per year). Moreover, the investment conditions may specify that the redemption of units can be suspended for a period of up to three years. In addition to the risks inherent in real estate investment, there are therefore specific risks associated with restricted redemption or liquidity.

6.2 Specific Risks

Income Risk (Yield Risk): Acquiring real estate requires a high initial investment, which is amortized over time through cash flows from rent and leases. However, the income situation can be relatively easily disrupted by limitations on usability in terms of time and substance, so the amortization of the initial investment may take longer.
Valuation Risk: A variety of criteria play a role in valuing a property (location, size, surroundings, usable area, interest rate level, etc.). Additionally, the real estate market consists of spatially separate submarkets. For these reasons, real estate valuation is subject to numerous uncertainties that are difficult to predict individually.
Liquidity Risk: Real estate represents a relatively illiquid asset class because, due to the high individuality of properties and the existence of submarkets, the process of valuation, sale, and transfer of ownership can take a long time. Rapid realization of a property’s value is therefore usually not possible. Indirect acquisition of real estate through shares in real estate companies mitigates this risk.
Transaction Costs: The process of valuation, sale, and transfer of ownership for direct real estate investments incurs relatively high costs compared to financial investments.
Price Risk: When investing indirectly in real estate by acquiring shares in real estate funds or REITs, the investor is exposed to price risk. The price can change due to general market fluctuations without the fund’s situation having changed.

7. Open-Ended Investment Funds (Mutual Funds)

7.1. General

Investment funds are vehicles for collective investment. In Germany, they are subject to the provisions of the Capital Investment Code (Kapitalanlagegesetzbuch – KAGB). Foreign investment funds may be organized similarly or identically to German investment funds. However, significant legal or other differences may exist. If foreign investment funds are distributed in Germany, certain legal requirements must be met, compliance with which is monitored by the Federal Financial Supervisory Authority (BaFin).
Open-ended investment funds (unlike closed-ended investment funds) are open to an unlimited number of investors. In an open-ended investment fund, a management company usually pools the funds of many investors into a separate pool of assets (Sondervermögen). However, special forms of investment funds are also possible (such as investment stock corporations or investment limited partnerships). The management company invests these funds according to a defined investment strategy and the principle of risk diversification in various assets (securities, money market instruments, bank deposits, derivative instruments, real estate) and manages them professionally. The fund assets, as separate assets, must be strictly segregated from the assets of the management company for investor protection reasons. For this reason, the assets belonging to the investment fund are held by the so-called depositary (custodian bank).
Investors can acquire co-ownership rights in the fund assets at any time by purchasing investment fund units through a credit institution or the management company. The value of a single investment fund unit is calculated as the value of the fund assets divided by the number of issued investment fund units. The value of the fund assets is usually determined according to a predefined valuation procedure. For exchange-traded investment funds, continuous stock exchange trading is also available for price discovery and acquisition.
The liquidation of investment units can occur in two ways. Firstly, there is generally the possibility of returning the investment fund units to the management company at the official redemption price. Secondly, the investment fund units may possibly be traded on a stock exchange. In both cases of acquisition and liquidation of investment fund units, third-party costs may arise (e.g., front-end load, redemption fee, commission).
The key investor information document (KIID), the sales prospectus, and the investment conditions provide information about the investment strategy, ongoing costs (management fee, operating costs, depositary costs, etc.), and other essential information about the open-ended investment fund. Additionally, the semi-annual and annual reports to be published are an important source of information.
The different types of open-ended investment funds can be differentiated based on the following criteria, among others:

Type of Management: A distinction is made between active and passive management. The goal of active management is to positively shape performance through continuous portfolio adjustment. In contrast, with passive management, performance is closely linked to the development of a tracked index.
Composition: Fund assets can consist of various asset classes (e.g., shares, fixed-income securities, commodities).
Geographical Focus: Open-ended investment funds can concentrate on specific countries or regions or invest globally.
Time Horizon: Open-ended investment funds can have a fixed or unlimited term.
Income Use: Open-ended investment funds can distribute income regularly or reinvest it to increase fund assets (accumulate).
Currency: The prices of investment fund units of open-ended investment funds can be offered in Euros or a foreign currency.
Hedging/Guarantee: The management company or a third party may guarantee a certain performance, certain distributions, or a certain preservation of value.

7.2. Specific Risks

Fund Management Risk: The specific investment decisions are made by the management of the management company. The investor cannot influence the composition of the fund assets.
Costs: Professional management of the fund incurs additional costs that would not arise if the securities held in the fund were acquired directly. Often, there are also one-off front-end loads, which, together with the ongoing management costs, make up the total costs of this investment form and can adversely affect the investment’s return depending on the holding period. The investor should therefore always consider the total costs when buying an investment fund (especially management costs, transaction costs, front-end load, and redemption fee).
General Market Risk: Broad diversification of fund assets according to various criteria cannot prevent a general downturn in one or more stock markets from being reflected in significant declines in unit prices.
Misinterpretation of Performance Statistics: When so-called performance statistics are used to assess the fund’s past investment success, there is a specific risk of misinterpretation. It should be particularly noted that past price developments cannot contain any guarantee regarding future price developments.
Risk Concentration: Risk concentration increases with the increasing specialization of a fund, for example, in a certain region, sector, or currency. However, this increased risk can also bring increased return opportunities.
Risk of Suspension and Liquidation: The management company may, under certain circumstances, temporarily restrict, suspend, or permanently cease the issuance of fund units.
Risk of Transfer or Termination of the Investment Fund: Under certain conditions, both the transfer of the separate assets to another separate pool of assets and the termination of management by the management company are possible. In the event of a transfer, continued management may occur under less favorable conditions. In the event of termination, there is a risk of (future) foregone profits.
Risk from the Use of Derivatives: Investment funds may invest in derivatives (especially options, financial futures, and swaps). These can be used not only for hedging the investment fund but also form part of the investment policy. The leverage effect of derivative transactions also causes stronger participation in the price movements of the underlying asset. This can lead to an indeterminable risk of loss when the transaction is concluded.
Use of Securities Lending Transactions: An investment fund may enter into securities lending transactions to optimize returns. If a borrower cannot meet its obligation to return the securities and the provided collateral has lost value, the investment fund faces potential losses.

7.3. Exchange Traded Funds (ETFs) in Particular

Exchange Traded Funds (“ETFs”) are exchange-traded open-ended investment funds that replicate the performance of an index – such as the DAX. They are also referred to as passive index funds. In contrast to active investment strategies, which aim to achieve excess return (“outperformance”) compared to a benchmark index (“benchmark”) through the selection of individual securities (“stock picking”) and determining favorable entry and exit points (“market timing”), a passive investment strategy is designed not to outperform a benchmark index, but to replicate it at the lowest possible cost.
Like other open-ended investment funds, ETFs give investors access to a broad portfolio of shares, bonds, or other asset categories such as commodities or real estate. Unlike other open-ended investment funds, ETFs are usually not bought or sold directly from a management company; instead, trading takes place on a stock exchange or another trading venue. An ETF can therefore be traded like a share on stock exchanges. To improve liquidity, market makers are usually appointed for ETFs, who are intended to ensure sufficient liquidity by regularly providing bid and ask prices. However, there is no obligation to provide liquidity.
ETFs can replicate their underlying indices in two different ways. With physical replication, the index is replicated by purchasing all index constituents (e.g., the 40 shares of the DAX) or, if applicable, a relevant subset. With synthetic replication, the ETF provider enters into an agreement in the form of a swap transaction (“swap”) with one or more banks, in which the exact performance of the desired index is guaranteed and collateralized. A synthetic ETF therefore generally does not hold the underlying securities.

7.4. Specific Risks of ETFs

ETFs are a special type of open-ended investment fund. They are therefore subject to the same risks as other types of open-ended investment funds (see above). In addition, there are ETF-specific risks:

Price Risk: Since ETFs passively replicate an underlying index and are not actively managed, they generally bear the underlying risks of the indices they track. ETFs thus fluctuate directly in proportion to their underlying index. The risk-return profile of ETFs and their underlying indices are therefore very similar. If the DAX falls by 10%, for example, the price of an ETF tracking the DAX will also fall by approximately 10%.
Exchange Rate Risk: ETFs contain exchange rate risks if their underlying index is not denominated in the currency of the ETF. If the index currency weakens against the ETF’s currency, the ETF’s performance is negatively affected.
Liquidity Risk: Particularly in illiquid market phases, there is a risk that the ETF price deviates from the fund’s intrinsic value (Net Asset Value – NAV). This can arise, for example, from a lack of liquidity in the asset class replicated by the ETF (the so-called underlying) and associated inefficiencies in the so-called creation/redemption process (i.e., the issuance and redemption of ETF units).
Replication Risk (Tracking Error): ETFs are also subject to replication risk, i.e., deviations can occur between the value of the index and the ETF (“tracking error”). This tracking error can exceed the difference in performance caused by the ETF fees. Such a deviation can be caused, for example, by cash holdings, rebalancing, corporate actions, dividend payments, or the tax treatment of dividends.
Counterparty Risk: Furthermore, with synthetically replicating ETFs, there is counterparty risk. Should a swap counterparty fail to meet its payment obligations, losses may occur for the investor.
Over-the-Counter (OTC) Trading Aspects: If ETFs and their underlying components are traded on different exchanges with different trading hours, there is a risk that trades in these ETFs are executed outside the trading hours of the respective components. This can lead to a deviation in performance compared to the underlying index.

7.5. Criteria for Selection

When selecting ETFs, the following criteria should be particularly considered:

Low Costs: Cost avoidance is one of the most important criteria for long-term investment success. When selecting ETFs, particular attention should be paid to the total costs of index replication (“Total Expense Ratio”, TER) as well as the broader total costs of an investment (“Total Cost of Ownership”, TCO), which additionally consider external trading costs such as bid-ask spreads, taxes, and brokerage commissions.
High Liquidity: ETFs with low trading liquidity generally have wider bid-ask spreads, which increases trading costs. ETFs with large investment volumes and multiple market makers should be preferred during selection to ensure the best possible tradability and keep trading costs low.
Low Tracking Error: The tracking error indicates the accuracy of index replication. It is advisable to look for a small deviation in the ETF’s performance from the underlying index to achieve the most accurate representation of the intended investment market.
Adequate Diversification: ETFs usually replicate broad indices with a multitude of individual securities. Depending on the ETF, these can be spread across countries, currencies, and sectors. This broad risk diversification provides access to the fundamental return drivers of the respective asset class without taking on high individual risks. However, very broadly diversified indices can also contain a number of small companies with low liquidity and thus higher trading costs. When selecting, a balanced and favorable ratio of risk diversification and implicit trading costs of the ETFs should be sought.
Robust Replication Method: ETFs are offered in two basic versions: with physical and synthetic replication of the underlying index. Synthetically replicating ETFs have a higher risk profile compared to physically replicating ones, as synthetic ETFs depend on their swap counterparties and thus bear a certain default risk. Therefore, physically replicating ETFs are often preferred due to their somewhat more robust and reliable investment form. However, for investing in certain markets, such as commodity markets or individual emerging markets, physical replication is not possible or not economical. In these cases, synthetically replicating ETFs offer a good market access opportunity.

Furthermore, so-called “ESG criteria” can also be considered when selecting ETFs. These are factors that characterize specific Environmental, Social, and Governance risks. ESG criteria are used to assess the extent to which companies align their organization and business practices with these factors. Certain indices and corresponding ETFs only replicate companies that operate considering ESG criteria. Thus, paying attention to these criteria when selecting ETFs can also be suitable for mitigating certain risks and possibly giving effect to idealistic goals in investment. However, when selecting an ESG-compliant ETF, the criteria explained above should always be considered as well.

8. Cryptocurrencies

8.1. General

Cryptocurrencies, also called virtual currencies, are defined as a digital representation of value that is not created or guaranteed by a central bank or public authority and does not necessarily have a link to legal tender. Similar to central bank currencies, cryptocurrencies are used as a medium of exchange and can be electronically transferred, stored, or traded. Examples of well-known cryptocurrencies are Bitcoin (BTC), Ether (ETH), Ripple (XRP), and Litecoin (LTC).
As fungible units of value, so-called tokens, cryptocurrencies or other assets are digitally generated in a publicly viewable database distributed across a multitude of network participants (“Distributed Ledger”). The creation of new tokens usually occurs through a computationally intensive, cryptographically secured process (“Proof of Work”), known as “mining.” New information, such as transaction data, is communicated by so-called “nodes” within the peer-to-peer network, validated, and added to the database in blocks almost irreversibly by “miners.” Since this process resembles a chain, this decentralized database is also called a “blockchain.” The blockchain records the entire history of the database. A copy of the transaction history is stored by all network participants. Consensus is defined by rules according to which the protocol of the decentralized network operates.

8.2. Representation via Exchange-Traded Products (ETPs)

Besides direct investment in cryptocurrencies via the corresponding crypto platforms or exchanges, investment is also possible via exchange-traded securities (Exchange-Traded Products, “ETPs”) that track the value development of an underlying asset, e.g., cryptocurrencies. The buyer of an ETP (usually) has a claim against the ETP issuer for payment of a certain amount of money or delivery of the underlying asset. The terms and conditions of such a claim are typically explained in the issuer’s product documentation. Should the issuer become insolvent and/or any collateralization of the product not hold its value, or if the delivery of the underlying asset is partially or completely impossible, the investor can thus suffer a significant loss up to a total loss.

8.3. Specific Risks

Price Risk: Cryptocurrencies are regularly subject to particularly high price fluctuations. The investor can thus suffer significant losses within a very short time. The prices of cryptocurrencies are determined exclusively by supply and demand and are historically significantly more volatile than traditional currencies and many other asset classes. Cryptocurrencies have no objectively quantifiable intrinsic value. Valuation models, e.g., of network effects and utility values of the different cryptocurrencies, are subject to subjective assumptions. Price formation depends heavily on the different interpretations of accessible information by market participants. The value of cryptocurrencies can fluctuate significantly within a very short time. A potential, permanent, and complete loss of value of a cryptocurrency arises if acceptance and thus the market for a respective cryptocurrency dwindle. Cryptocurrencies are not legally recognized means of payment. The use and acceptance of cryptocurrencies, e.g., for purchasing goods and services or as a store of value, is therefore not guaranteed.
Liquidity Risk: Timely tradability may not always be guaranteed. The investor may not be able to sell their positions immediately or only by realizing a significant price loss. Furthermore, trading in individual cryptocurrencies may be suspended temporarily or completely without notice. When represented via ETPs, there is an additional risk due to shorter trading hours of the ETP compared to the trading hours of the respective cryptocurrencies. As a result, the investor may not be able to react immediately to market movements of the underlying asset.
Custody Risk: Cryptocurrencies are stored at publicly viewable blockchain addresses within a self-managed or, in the case of representation via ETP, third-party managed “wallet” by securing the associated private cryptographic keys (“Private Keys”). Loss or incorrect handling of these keys can lead to the complete loss of access to the tokens. Lost, unsecured keys cannot be recovered. Furthermore, unauthorized persons, e.g., through inadequate protection against spyware, can gain access and irrevocably transfer the tokens.
Issuer Risk: When represented via ETPs, the investor acquires units in financial instruments that track the value development of certain cryptocurrencies. These products are bearer debt securities of the issuer. Should the issuer become insolvent and/or any collateralization of the product not hold its value, or if the delivery of the underlying asset is partially or completely impossible, the investor can thus suffer a significant loss up to a total loss.
Legal and Political Risks: The ownership and trading of cryptocurrencies can be restricted or completely prohibited by state authorities and governments. This can lead to a significant decrease in the general market acceptance of individual or all cryptocurrencies, even if regulation only affects individual countries outside Germany or Europe.
Cryptography and Technology Risk: Cryptocurrencies are mostly based on open-source software and significantly on cryptographic algorithms. Even though the software is constantly being developed by a diverse community, there is a risk of serious, systematic programming errors. Also, the technology of another, new cryptocurrency may prove superior to the existing one. This can lead to a rapid decline in the usability, acceptance, and thus the value of the affected cryptocurrency.
Transaction Risk: Transactions on the blockchain are irreversible. An incorrect entry of the public wallet address (“Public Key”) during a transfer leads to the permanent loss of the transferred tokens.
Risk from Trading Halts and Disruptions: Trading in cryptocurrencies may be interrupted temporarily, for example, due to technical disruptions or by the execution venue, or may be temporarily unavailable for other reasons. The investor may consequently be unable to sell cryptocurrencies. Losses, up to a total loss, may occur during this time.
Network Risk (51% Attack): If more than half of the computing power of a Proof-of-Work blockchain is controlled by one or a group of miners, the integrity and immutability of the blockchain are no longer guaranteed. As a direct consequence, new blocks with valid transactions can be withheld, or double spending can occur. An immediate price collapse of the cryptocurrency is to be expected if the decentralization of the network is no longer given.
Hard Fork Risk: Further developments of cryptocurrency software through a protocol change of the blockchain are usually carried out seamlessly via a “soft fork.” An update of the individually used wallet or node software is not necessary for network participants to continue using the cryptocurrency. With a “hard fork,” however, a protocol change is no longer compatible with the previous protocol. If not all network participants reach consensus on the new protocol, a second, alternative blockchain splits off. The market decides which of the two parallel and competing blockchains is the “legitimate” cryptocurrency. The most famous “hard fork” occurred in 2017 when the blockchain and community of the cryptocurrency Bitcoin Cash (BCH) split off from Bitcoin (BTC).
Market Manipulation Risk: Cryptocurrencies are sometimes traded unregulated and without state supervision. Market and price manipulation by individual market participants cannot be excluded.

9. Certificates, Leveraged Products, Warrants, and Other Complex Financial Instruments (“Derivatives”)

9.1. General

Certificates, leveraged products, warrants, and other complex financial instruments (“derivatives”) are legally considered debt securities. They can represent the investor’s claim against the issuer for repayment of a sum of money or delivery of financial instruments or other assets, and possibly also for payments during the term. The performance of a derivative depends on the performance of one or more underlying assets. Underlying assets can include, for example, individual shares, baskets of shares, currencies, commodities, or indices.
Derivatives can have fixed terms, e.g., over several years, or be issued without a fixed term limit, also called “Open End.” Depending on the structure, both the issuer may have a right of termination, leading to early repayment, and the investor may receive a so-called exercise or redemption right during the term or at defined points in time. Details are further explained in the product conditions of the respective derivative.
The performance of a derivative depends on the development of the respective underlying asset and the structure of the respective product. Depending on the structure, factors such as dividend payments, interest rates, exchange rates, or volatility can affect the value of the derivative.
To calculate the unit price of a derivative, the issuer uses the theoretical fair value based on financial mathematical models. A possible difference between the determined theoretical value and the actual unit price can result, for example, from the issuer’s margin, any distribution fees, and the costs for structuring, pricing, settlement, and hedging the product. Accordingly, the bid and ask prices (bid and offer prices) quoted by the issuer during the term are not based directly on supply and demand for the respective product, but rather on the issuer’s pricing models.
When pricing by the issuer, costs do not have to be distributed evenly over the term but can be deducted already at the beginning of the term. Cost types include, for example, charged management fees or margins embedded in the products.

9.2. Specific Risks

Issuer/Credit Risk: Analogous to investing in bonds, investing in derivatives carries the default risk of the issuer. If the issuer cannot meet its obligation to the investor, the investor faces a total loss. Unlike equity investors, a bond investor is generally better positioned in insolvency because they provide debt capital to the issuer and their claim may be (partially) satisfied from any resulting insolvency estate. The creditworthiness of many issuers is assessed at regular intervals by rating agencies and divided into risk classes (so-called ratings). Ratings should not be understood as a recommendation for an investment decision. Rather, they can be included as information in the corresponding consideration of an investment decision by the investor.
Price Risk: All factors that affect the price of the underlying asset also affect the price of the derivative through changes in the price of the underlying asset. In principle, the derivative is subject to higher price fluctuations the more volatile the price of the underlying asset is. Other aspects can influence the price development of a derivative. Depending on the product structure, these can include, among others, the interest rate level, dividend payments, or exchange rates to foreign currencies.
Risk from Leverage Effect and Knock-Out: With leveraged products, the price risk can be significantly amplified by the leverage effect. With knock-out products, there is additionally the risk of a total loss due to interim price fluctuations that lead to reaching the knock-out barrier.
Currency Risk: For derivatives based on underlying assets not denominated in Euro, there is an exchange rate risk. If the foreign currency loses value against the Euro, losses may occur for the investor, even if the price of the underlying asset develops positively. Currency risk can be eliminated, for example, by derivatives with a so-called quanto structure (currency-hedged).
Liquidity Risk: Investment in a derivative is generally geared towards a certain duration. There is no guarantee that the derivative can be regularly traded during its term. If the investor needs the invested capital, they may not be able to sell the derivative or only sell it at high discounts. The difference between the bid and ask price (spread) can be high, especially in highly fluctuating markets. Possible illiquidity can lead to non-market prices. In case of early sale, the investor also possibly forgoes payments that only become due at a later date or at the end of the term.
Risk of Delivery of the Underlying Asset: For products based on a single underlying asset, such as a share, delivery of the underlying asset may be provided for. Depending on the structure, the investor may receive the underlying asset instead of a cash payment in certain scenarios. The current market value of the underlying asset can be considerably lower than the purchase price paid for the derivative.
Termination and Reinvestment Risk: The issuer may terminate the term of the derivative with immediate effect upon the occurrence of certain events listed in the respective product conditions, or in case of obviously incorrect product conditions, or make an adjustment to the conditions. In the event of termination, the investor receives a payout equal to the market price determined by the issuer or the amount provided for in the product conditions. The payout can be considerably lower than the purchase price paid for the derivative. In addition, the investor bears the risk that the timing of the termination is unfavorable for them and they can only reinvest the payout amount under worse conditions.
Costs: Depending on the structure, derivatives may be subject to costs that negatively affect performance. Details on costs are further explained in the product conditions of the respective derivative.
Risk from Trading Halts and Disruptions: Trading in derivatives may be interrupted temporarily, for example, due to technical disruptions, by the issuer, or by the execution venue, or may be temporarily unavailable for other reasons. The investor may consequently be unable to sell the derivative. Losses, up to a total loss (e.g., with knock-out products), may occur during this time.
Risk due to Complex Structure: Due to the extensive design possibilities of derivatives, the specific structures and associated risks can be difficult for the investor to understand. Before purchasing, the investor should therefore absolutely familiarize themselves with the Key Investor Information Document (KIID) and other product information from the manufacturer for the respective derivative.

9.3. Important Types of Derivatives

In principle, derivatives can be divided into the categories of leveraged products and investment products.
Leveraged products can participate more strongly in the performance of the underlying asset via the so-called leverage – this also means that the associated risks (esp. price risk and risk from leverage effect and knock-out) increase. Some types of leveraged products have a so-called knock-out barrier, upon touching which the relevant product expires worthless. As a result, the investor can no longer participate in the subsequent performance of the underlying asset.

Warrants (Optionsscheine) certify the right to buy (call option) or sell (put option) the underlying asset, according to a specific subscription ratio, at a predetermined strike price, within a subscription period (American option) or at the end of a subscription period (European option).
Instead of the actual acquisition or sale involving the delivery of the underlying asset, the product conditions of warrants typically provide for the payment of a cash settlement amount in Euro. In case of a payment, no purchase (and conversely no sale) of the underlying asset takes place upon option exercise; rather, the difference between the agreed strike price and the current market value of the underlying asset is determined and paid out to the investor.
The price of a warrant is influenced, among other things, by the performance of the underlying asset, the (remaining) term, and volatility. Thus, the price is directly related to the underlying asset but is usually significantly lower. This means that the buyer of the warrant can participate proportionally more strongly in price changes of the underlying asset than with direct investment in the underlying asset. This effect is also called the “leverage effect.” Accordingly, price risks are more pronounced and can lead to a total loss of the investment.
Leverage Certificates (Hebelzertifikate) also allow the investor to participate disproportionately in the price movements of the underlying asset. This means that price losses of the underlying asset impact the investor’s investment more strongly than would be the case with direct investment in the underlying asset. The product thus carries a greater risk, up to a total loss. Similar to warrants, leverage certificates also offer the possibility to profit from rising prices of the underlying asset (Long or Bull products), or falling prices (Short or Bear products).
A relevant difference to warrants is the so-called knock-out barrier. If this barrier is touched, the instrument becomes worthless, and the investor suffers a total loss.
Factor Certificates (Faktorzertifikate) offer another way to participate disproportionately in the performance of the underlying asset. The performance of a factor certificate results from the intra-day value change of the underlying asset, multiplied by the respective factor. Because the certificate’s performance is always calculated against the respective previous day’s closing price of the underlying asset, path dependency arises. This carries significant risks, and losses can occur in the factor certificate even during sideways phases of the underlying asset.

Investment products can be divided into products that participate directly in the performance of the underlying asset and those with a predefined repayment profile.

The latter category includes, for example, Discount Certificates (Discountzertifikate). These can be purchased at a price below the current price of the underlying asset. This price discount – also called the “discount” – acts as a risk buffer and may still allow for positive returns even if the price of the underlying asset moves sideways. In return, the investor forgoes participation in a strong price increase, as the return opportunity is limited by an upper threshold, the so-called “Cap.”
Express Certificates (Expresszertifikate) also follow a predefined payout profile. At specific observation dates, the performance of the underlying asset is reviewed. If the underlying asset is trading above the starting price, the investor receives a payout of the certificate’s nominal value plus a defined express amount. If the underlying asset is below the starting price, this review is repeated at the next observation date. In case of price losses, a safety buffer may be provided, which can protect the investor from price setbacks down to a predetermined level. However, if the prices of the underlying asset fall beyond this, the investor faces the same risk as with a direct investment in the underlying asset.
As classic participation certificates, Index Certificates (Indexzertifikate) have, for example, a stock, security, or commodity index as the underlying asset. They replicate the development of the underlying index one-to-one. Thus, they are particularly suitable for investors who wish to implement the investment strategy of a specific index. An alternative to index certificates are index funds, which also replicate an index. Index certificates usually incur lower costs compared to index funds but are associated with additional risks (like issuer risk).
If the certificate is based on a stock index, it should be noted whether the certificate refers to a total return index (Performanceindex) or a price index (Kursindex). With a total return index, dividend payments are included, whereas with a price index, they are not. For indices not denominated in Euro, there is also a currency risk. This can, however, be eliminated with so-called Quanto index certificates.
Basket Certificates (Korbzertifikate) replicate a basket of shares or other investment products and are a variation of index certificates. The certificates differ regarding the distribution of dividends, the mechanism for maintaining the basket composition, and the management fee charged for this.
Another form of complex financial instruments are so-called complex ETFs. Analogous to the derivatives described above, complex ETFs can also, depending on their structure, achieve a leverage effect (e.g., Leveraged ETFs) and/or counter-directional participation in the performance of the underlying asset (e.g., Short ETFs). In addition to the risks of all other complex financial instruments, as well as the specific risks of synthetically replicating ETFs already mentioned, complex ETFs can also carry the particular risk arising from the daily resetting of the leverage or short factor. Because the performance is calculated daily against the respective previous day’s closing price of the underlying asset, path dependency arises. Even if the underlying asset trends sideways over several days, the ETF can suffer losses.

IV. Functioning and Risks of Trading Securities

1. General

Buy and sell orders are executed by the custodian bank according to its special conditions for securities transactions and its execution policy. If the orders are placed by an asset manager, their selection or execution policy must also be observed. In addition, the respective policies on handling conflicts of interest (“Conflict of Interest Policies”) may contain relevant provisions. Where applicable, when executed by a third party, the customer’s orders may be aggregated with orders from other customers. Such so-called aggregated orders (or block orders) enable cost-effective trading of securities and are therefore generally advantageous for the customer, as without them, providing a cost-effective service to a large number of customers would be impossible. However, aggregated orders can also be disadvantageous for the individual customer in specific cases. They can, for example, have a negative impact on price formation in the market or lead to a reduced allocation for individual customers due to excessive order volume.

2. Commission and Fixed Price

Dispositions regarding securities made for the investor by a third party can occur, among other ways, through fixed-price transactions or on a commission basis. In a fixed-price transaction, the third party (e.g., the bank) sells or buys the corresponding securities directly to or from the customer at an agreed price. On a commission basis, the third party buys or sells the corresponding securities for the account of the customer, so that the conditions agreed with the counterparty (i.e., the buyer or seller) are economically attributed to the customer.

3. Securities Trading

Securities trading can be executed on stock exchanges or off-exchange trading venues, such as in interbank trading or within multilateral trading facilities (MTFs):

Stock exchanges are centralized and organized markets for trading securities and other financial instruments, regulated and supervised by state-recognized bodies. On these exchanges, the supply and demand of a multitude of market participants are brought together. Trading on stock exchanges takes place regularly; securities admitted to trading on the exchange are traded accordingly. Trading and price determination are regulated accordingly. The different types of exchanges can be differentiated, among other things, by the density of regulation (regulated market or open market/Freiverkehr) and the type of trading (floor trading or electronic trading system). In Germany, stock exchange trading takes place at various trading venues. Trading is mostly conducted via electronic trading systems. Compliance with the predefined rules is monitored by the stock exchange supervisory authority.
Off-exchange trading, also referred to as direct trading or OTC (“over the counter”) trading, includes any trading that takes place outside a stock exchange. Here, the investor can, for example, trade directly with the issuer or a so-called market maker.

3.1. Price Determination

In floor trading, the so-called official broker (Skontroführer) determines the corresponding price either within the framework of continuous trading or based on a single price auction (Einheitskurs). When determining the single price, the principle of maximum executable volume (Meistausführungsprinzip) applies. This means that the price determined as the execution price is the one at which the largest volume can be traded with the smallest imbalance. In electronic trading, price determination occurs through electronic systems according to specific rules and usually also observing the principle of maximum executable volume. To increase the tradability of less liquid securities and thus the possibility of concluding transactions, exchanges allow the issuer or third parties commissioned by them to provide additional liquidity. For this purpose, exchanges conclude contracts with banks, brokerage firms, or securities trading houses. As so-called market makers, these commit to continuously quoting buy and sell offers (quotes) for the securities they manage. A quote is a bid and ask price for a security. The lower bid price indicates the price at which the investor can sell the security; the higher ask price corresponds to the price at which the investor can buy the security.

3.2. Instructions (Orders)

Buy and sell orders are executed by the custodian bank according to its special conditions for securities transactions and its execution policy. However, customer instructions take precedence. These instructions can specify price and time limits (limits, validity period, or limit qualifiers). In this way, the customer can “fine-tune” the respective order. Particularly relevant examples of instructions will be explained below:

Market Order (also Bestens-Order): A market order designates an order to buy or sell a security at the next available price. For buy orders, this is the lowest sell offer, and for sell orders, the highest buy offer. If these buy or sell offers do not have sufficient volume, the remaining shares are bought or sold at the respective next offers until the entire order volume is processed. Since the investor does not specify a price limit, it is also called an unlitmited order. Market orders are usually executed relatively quickly. However, there is a risk that execution will occur at a worse price than desired.
Limit Order: With a limit order, a price is always set that establishes the (upper or lower) limit for a purchase or sale. Execution thus occurs at the desired price or a better one. If the price set as the limit is not reached, a limit order may not be executed within the order’s validity period.
Stop-Loss Order: A stop-loss order is a sell order instructing the bank to automatically sell a security as soon as a price level set by the customer below the current market price is reached or breached. However, the stop-loss order is not a guarantee that the security will be sold at the desired price level. The order merely triggers an instruction when the specified price level is reached, which is then submitted to the market as a “market order” (Bestens-Order).

Time instructions are also possible; here, the investor specifies, in particular, how long the order they placed is valid. Without additional instructions, market orders are generally limited to the specific trading day, while limit orders can typically be valid for one month up to a year if not canceled beforehand by the investor.

4. Specific Risks

Transmission Risk: If the investor does not place clear orders, there is a risk of errors in order execution.
Lack of Market Liquidity: In the absence of market liquidity, the investor’s corresponding order may not be executed or only executed with delay. For example, it may happen that no buyer can be found for the investor’s shares in a sale. The risk depends particularly on the type of security. Shares of DAX companies, for example, are very liquid, while shares traded on the so-called unregulated open market (Freiverkehr) may be very illiquid under certain circumstances.
Price Risk: A certain amount of time may elapse between order placement and execution. This can lead to the market price developing unfavorably in the meantime.
Trading Suspension and Other Protective Measures: Stock exchange trading can be suspended if orderly trading is temporarily endangered or if this appears necessary for the protection of investors. Furthermore, trading interruptions may occur due to increased volatility of market prices (so-called volatility interruptions). In the event of a price suspension on a German stock exchange, the customer order to buy or sell the relevant security is not executed and expires.
Aggregated Orders (Block Orders): They can have a negative impact on price formation in the market or lead to a reduced allocation for the individual investor due to excessive order volume. For the latter case, the principles of order allocation of the custodian bank and, if applicable, the asset manager apply, which regulate the proper allocation of aggregated orders and transactions, taking into account the influence of volume and price on the allocation and partial execution of orders.
Risks in Intraday Trading (so-called Day Trading): Buying and selling a financial instrument within the same trading day is called “Day Trading.” The aim is to exploit small and short-term price fluctuations. Besides the risk of short-term, sharp price swings, there is particularly the risk of increased costs in this case. In addition to any fees, the difference between the bid and ask spread must also be considered for each buy/sell combination.

V. Functioning and Risks of Investment Services

Various investment services are offered for investment. Before the investor decides on an offer, it is very important to understand the differences and the associated typical risks and conflicts of interest.

1. Execution-Only Business and Non-Advised Business
In the execution-only business, the custodian bank merely acts upon the customer’s instruction in executing securities orders. No advice or appropriateness test is provided. Due to legal regulations, execution-only transactions may only be carried out for non-complex financial instruments (e.g., shares, money market instruments, debt securities, or retail funds). The customer receives a securities transaction confirmation containing the essential execution data.
A non-advised transaction occurs when the customer makes an investment decision without having previously received an investment recommendation from a bank. The bank’s duty to gather information (Explorationspflicht) is significantly reduced compared to investment advice or portfolio management. In contrast to the execution-only business, however, there is at least a limited duty to gather information and an obligation to conduct an appropriateness test.

2. Investment Broking and Contract Broking (Anlage- und Abschlussvermittlung)
With investment broking and contract broking, no advice is given to the customer. The customer is merely brokered a financial product. A suitability test of the financial investment for the customer is not required and therefore does not take place or only to a limited extent. In broking, typically only or predominantly the financial product being brokered is promoted. The customer might mistakenly get the impression that this constitutes investment advice.
Investment broking involves receiving and transmitting customer orders relating to the acquisition and disposal of financial instruments. Distribution is mostly based on oral explanations of the investment concept, possibly accompanied by the handing over of prospectuses or other sales documents. The investment broker has no explicit power of attorney from the customer and acts only as a messenger.
Contract broking, on the other hand, means acquiring and disposing of financial instruments in the name of and for the account of others. Customer orders are processed via a third party (contract broker). The contract broker thus acts as a representative with corresponding authority to act on behalf of their customer. The contract is thus concluded directly between the customer and the seller of the securities.

3. Investment Advice
In investment advice, an investment advisor recommends specific securities to the customer for purchase or sale. The advisor is obliged to check the suitability of the recommended investment for the customer, considering their investment objectives, financial situation, risk tolerance, as well as their knowledge and experience. However, the decision to implement the advisor’s recommendation must be made by the customer themselves.
There are basically two remuneration models: fee-based and commission-based advice. The remuneration of both types of investment advice entails potential conflicts. With fee-based advice, the advisory service is usually billed directly to the customer on an hourly basis. This creates an incentive for the advisor to bill as many consulting hours as possible. With commission-based advice, the service is not billed directly to the customer, as the advisor receives a commission from their employer or from the provider of the investment product (e.g., from the fund company or the issuer of a certificate). This carries the risk that the customer is not offered the most suitable security for them, but rather the one that is most lucrative for the advisor.

4. Portfolio Management (Finanzportfolioverwaltung)
Portfolio management (also called asset management) differs from the previously described investment services. While asset management differs from brokerage services in the primacy of the investor’s interest (as opposed to the interest of the capital seeker), it can be distinguished from advisory services both by the discretionary power over the investor’s assets and by the long-term nature of the contractual relationship. Portfolio management shares with investment advice the requirement that the institution must check the suitability of the investment for the customer, considering their investment objectives, financial situation, risk tolerance, as well as their knowledge and experience.
The asset manager receives authorization from the customer to make investment decisions at their own discretion if they appear appropriate for managing the customer’s assets. Although the asset manager does not need to obtain instructions from the customer for investment decisions, they are bound by the previously agreed investment guidelines, which regulate their powers, as well as the type and scope of the service.
Asset management is typically a service aimed at long-term wealth accumulation or preservation. The customer should therefore have a long-term investment horizon, as this increases the likelihood that the portfolio can recover in the event of negative performance. It is advisable to use only assets for asset management that are not needed to cover short- and medium-term living expenses or fulfill other liabilities.
Asset management is also associated with a number of risks for the customer’s financial situation. Although the asset manager is obliged to always act in the best interest of the customer, incorrect decisions and even misconduct can occur. Even without intent or negligence, deviations from the agreed investment guidelines can occur due to general market developments. The general risks of investment, as well as the specific risks of the asset classes used, persist even in the case of asset management.

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