Even among fund managers, exchange traded funds (ETFs) get a strong recommendation for the private investor, primarily because the return is more certain and the costs of investment lower.
When investing in a traditional unit trust, investors pay a percentage of their capital for a fund manager to trade with a view to outperforming the JSE index (typically about 1,5%), whereas logic dictates they can’t all succeed: if one outperforms, another has to under-perform.
Stalwart investment managers such as Armein Tyer, MD of Sanlam Investment Management and Citadel wealth planner Johan Strydom both recommend the JSE’s Satrix series, comprising 26 passively managed funds listed on the JSE.
The JSE’s promo for its ETFs explains: “These days, actively managed funds – those that research the market to look for attractive stocks that will outperform the overall market – are struggling to produce superior returns. Many investors prefer the reassurance of passively managed funds – those that follow an index without trying to outperform it. Index funds provide investors with all the benefits of diversification for the cost of one transaction.”
Low management costs
Their advantage is that they offer all the advantages of a unit trust, but with management costs of 0,4% (versus the 1,5%). ETFs cut costs by doing away with the analysts who actively manage funds. Instead they use the stock market as their shopping list, rebalancing it quarterly. They are also simpler: instead of having to choose from the 1 143 listed on the unit trust page, you select from the 26 – each of which relates to a well defined segment of an economic sector, like the blue chip Top 40, or sector-specific indices such as Industrial, Financial and Resources.
A diversified portfolio
The most popular ETF, Satrix 40, gives investors the performance of the FTSE/JSE’s Top 40 index. It enables investors to invest in a single security that provides a diversified portfolio of the top 40 companies, measured by their market capitalisation, on the JSE. It provides both the price performance of this index as well as paying out quarterly all the dividends received from the JSE’s top 40 companies.
The three most recently listed ETFs (the eRAFI range) introduce a new concept: they do not mirror new sectors, but instead use proprietary methodology based on six measures of economic value as opposed to traditional market weightings.
There are also ETFs that are weighted according to black economic empowerment (NewSA) or Islamic principles (Sharia 40).
The ETFs are typically designed by investment banks such as Deutsche Bank and Absa Capital, and come with their backing and reputation.
ETFs offer strong competition to unit trusts: to keep costs down they tend to be ”tracker” funds that in their underlying basket of shares mirror those used by the JSE to calculate the average growth of various sectors. By emulating the average of the sector, they achieve growth that is better than most actively managed funds – in the short-term.
Research does suggest that over the long-term, active management outperforms. However, such research is often imperfect as it employs perfect hindsight.
Logic dictates that passive investing has to outperform – on average. Actively-traded funds will perform below the index average because overall their performance will be no better (as a group) than the passively traded funds, but their costs will be higher because of higher transactions, management and advisory costs.
On the other hand, passive investing is an extremely boring strategy that resigns one to accepting the average. Picking your own shares is much more exciting, though statistically you run a 50% chance of ending up with below-average returns.
Paying for performance
Most investors want – and expect – to be above average. It is possibly for this reason that notwithstanding their advantages ETFs have gained only a tiny foothold in the market – internationally as much as in South Africa.
Sanlam’s Tyer claims to be mystified by why they have never gained more ground, especially in the private investment market. “The trick in investing is not to pay too much for passive management, but be prepared to pay for outperforming the index. If you can’t manage that, then you’re better off investing in one of the Satrix index funds,” adds Tyer.
One drawback of ETFs is that they are concentrated on equities: there is only one for property and two for bonds. This is because they are still relatively new, with the first local ETF, the Satrix Top 40, having listed in November 2000.