Are ETFs perfect for asset allocation?
There are two ways to use Exchange Traded Funds (ETFs) in your investment portfolio. One method, favoured by market speculators, is to utilise ETFs as tactical short-term trading instruments. ETFs are useful in this regard as they allow traders quick acce
Getting to grips with ETFs
ETFs were introduced in the United States in 1993. Although these financial instruments initially focussed on equities they were soon available on any asset class imaginable. “When ETFs were first launched in Europe and South Africa eight to 10 years ago they were typically on equity indices,” said Mistry, “now you have a full range of ETFs on bond indices covering government indices, corporate bonds, money markets and you get access to alternative asset classes like commodities and private equity.” You even get ETFs that are designed to act like trading products!
If you want a tag-line for an ETF then Mistry suggests adopting Deutsche Bank’s “simply buy the market!” This tag-line provides a powerful summary of what an ETF product does. It focuses on a sub-section of the financial markets (for example equities, bonds or alternatives) and then buys the underlying components in an appropriate index. Let’s consider a locally listed ETF which most South African investors are familiar with – the SATRIX 40. This is a traditional equity ETF that tracks the performance of the top 40 locally listed shares. Each time you purchase SATRIX 40 you gain exposure to the country’s top 40 shares according to their weighting in the JSE/FTSE TOP 40 Index. Instead of performing a complex calculation and placing 40 separate orders with your stock broker, you complete the transaction in one simple step.
Another extremely popular local ETF is New Gold Issuer Limited. The gold holdings in this fund topped R10bn in July this year. And Absa Capital, the issuer of the fund, had to move the physical gold that underpins the fund to London, due to a shortage of local storage space. Each ETF unit is equivalent to one-tenth of a troy ounce of gold. The New Gold ETF remains one of the most cost effective methods of exposure to the physical gold price available to local investors.
Growing like the clappers
South Africa’s ETF market is still in its infancy. We took a snapshot of the global ETF market at 30 June 2009 to demonstrate how popular these products have become. Global assets in ETF funds topped $809bn, with investors in the United States ($598bn), Europe ($156bn) and Asia ($55bn) leading the way. Despite appalling financial market conditions in 2008 these investors continued to pour billions into ETFs. “In the US we witnessed net inflows of more than $180bn through 2008,” said Mistry. Investors favoured the products despite equity market declines of 30% across a broad cross section of developed economies. The trend has continued in the first half of this year with net inflows to ETF products in the US and Europe topping $42bn and $13bn respectively!
The industry is in a continual state of flux. Deutsche Bank estimates there are already more than 1, 673 ETF products available globally. They are a large player internationally, offering more than 100 db x-tracker ETFs and in excess of 300 product listings in Europe and Asia. These include 63 equity produces, 37 fixed income products, four currency products, two commodity products and one hedge fund product. South Africa is some way behind the international ETF curve. At present we are limited to approximately 24 ETFs, of which Deutsche Bank administers 12, including seven SATRIX products and five db x-trackers.
Shifting investment trends
The long-term investment focus has shifted in recent times. “Traditionally fund managers have been stock pickers, priding themselves on being able to research the best stocks and including them in their portfolios,” said Mistry. But there is evidence that long-term portfolio returns hinge more on correct asset allocation than stock picking within a single major asset classes. As the universe of ETF products expands, more and more active managers are using them to fulfil the asset allocation function in their portfolios. The reason is that ETFs “are perfect building blocks for asset allocation.” Asset managers can satisfy a range of risk/return profiles by simply selecting an appropriate basket of ETFs. “More and more professional managers are including ETFs in their portfolios,” said Mistry. There are even some active managers who administer 100% ETF portfolios.
As an example he mentions the Wealth Management Total Return Index ETF established for quirin Bank in Germany. This company packaged their entire wealth management offering in one product. They assess the appropriate weighting across nine db x-tracker ETFs every two months. There is plenty of scope for growth in assets under management in the ETF universe. We expect it will take some time before local asset managers embrace ETFs over stock picking. Until then, the ETF “remains a flexible and easy-to-use investment tool” for the private investor.
Editor’s thoughts:
It’s probably too early to talk about using ETFs to implement asset allocation strategies for South African investors. International fund managers, however, have enough choice to seriously consider the move. Would you rather include an equity-ETF (which provides an index return) or an actively managed portfolio of shares in the equity component of your client’s portfolio? Add your comment below, or send it to [email protected]
