The number of index-tracking investments, designed to give you a simple, cheap way to “buy the market”, is growing by the day. The greater choice means you need a basic knowledge of these investments to be able to make an informed decision.
At the end of August, a survey by ETF provider etfSA found there were more than 90 rand-denominated index-tracking funds, exchange traded funds (ETFs) and exchange traded notes (ETNs). These are mostly passively managed funds that invest in the same shares that make up an index. They have lower costs, because they do not employ expensive fund managers to select shares or other securities.
Although investors looking for an index fund don’t face the same challenges as investors in actively managed funds who must choose from thousands of funds, complexity is creeping into the market.
This month saw the launch of four ETFs as index-tracking unit trusts and five new funds by First National Bank that decide for you whether to invest actively or passively.
Tracking the broad market
Investors who want an equity investment that enables them to “buy the market” should look for funds that track the broader market, rather than ones that focus on a specific sector, such as the industrial sector or the financial sector. Funds that track the FTSE/JSE All Share Index (Alsi) or the FTSE/JSE Top 40 Index (Top 40) are good options.
For many years, only a few index-tracking unit trust funds were available to ordinary investors. Two of these, the Gryphon All Share Tracker Fund and the Stanlib Index Fund, which track the Alsi and have delivered double-digit growth for more than 15 years – not too far behind the top-performing local equity funds. The future top-performing funds can be difficult to identify when you start investing.
The new wave of index-investing in South Africa started in 2000 with the launch of South Africa’s first ETF, the Satrix 40, which tracks the Top 40, the index of the top 40 companies on the JSE according to the amount invested in them, or their market capitalisation: the price of their shares multiplied by the number of shares in issue.
Since the launch of the Satrix 40, there has been significant growth in the number of funds that track the Alsi, the Top 40 or variations of these indices. You can now choose among funds tracking:
• The FTSE/JSE Shareholder Weighted Index (Swix), excluding shares that are not available to local investors because, for example, one company has a strategic shareholding in another, or because they are held on a stock exchange elsewhere in the world.
• The FTSE/JSE Capped All Share Index (Capi), which includes all the shares in the Alsi but caps very large shares at 10 percent.
• An Equally Weighted Top 40, which gives each share in the Top 40 an equal weighting and gives smaller weightings to large shares and higher ones to small shares.
• The S&P Top 50, which includes the Top 40 shares, as well as 10 smaller (mid-cap) shares.
The performance of these indices will vary depending on individual share’s performances and their weightings.
Investing with style
Until the emergence of so-called factor investing, or smart beta, you could track a market only in accordance with the market capitalisation of an index. But now there are a number of index-tracking investments that can give you access to the shares in the broader market in a way that mimics the stock selection of an active fund manager who follows a particular investment style.
Beta refers to the returns you can earn from the market without the intervention of a fund manager. A smart beta fund typically tilts the selection of securities available in the market to a theme or style, or filters them according to certain criteria. For example, you will find the following index-trackers:
• A Shari’ah Top 40 tracker that complies with Islamic investment principles.
• A Green ETF that tracks the shares of companies that excel in environmental ratings.
• Rafi (Research Affiliates Fundamental Index) Top 40 trackers, which weight shares according to a company’s sales, cash flow, book value and dividends, rather than its market capitalisation. This reduces the weighting of companies whose share prices have risen relative to other shares and increases the holdings in companies whose prices have fallen behind. In this way, Rafi trackers mimic the valuation-style of active managers.
• Low-volatility index-trackers, which track liquid shares with the lowest volatility – or the most stable share price – over the past year.
• Global Intrinsic Value Index (Givi) trackers, which are made up of the top 20 percent of shares measured on their profitability, quality of earnings and the strength of their balance sheet.
• High-dividend share-trackers, which follow indices that identify shares with high dividend yields (dividend payments relative to share price). The FTSE/JSE Dividend Plus Index selects the best dividend payers on the basis of the dividends expected over the coming year as a percentage of the share price, while the S&P Dividend Aristocrats Index equally weights shares (excluding property) that have increased or maintained stable dividends for at least five years.
• Momentum index-trackers identify shares that have had the greatest increase in price over the past year and are expected to perform well when value and low-volatility indices are under-performing.
Index-tracking funds that allow you to buy into the global market are still quite limited, but there have recently been a few additions. You can buy:
• The Deutsche Bank x-tracker Fund and the Satrix MSCI World Equity Index Feeder Fund, which track the MSCI World Index, which covers more than 1 600 shares listed on more than 20 stock exchanges around the world.
• The Old Mutual Global Rafi Index Fund, which tracks developed and emerging market equities in the FTSE/Rafi All World 3000 Index. Shares are selected and weighted in line with dividends, cash flows, sales and book value, rather than their market capitalisation.
• The French banking group PNB Paribas’s Guru Equity World ETN, which tracks some 1 200 companies from the most liquid global company stocks.
There are other index-tracking investments that target specific regions or markets. Be aware that some are ETNs.
BlackRock’s index-trackers require an investment in currencies other than rands. You will need to use your offshore investment allowance and find an investment platform that offers foreign currency investments or buy the iShares ETFs through a stockbroker.
Across asset classes
The market for index-tracking funds that invest across asset classes is growing slowly.
So far, there are four providers of multi-asset index-tracking funds that you can buy as a stand-alone investment. The stand-alone funds that are suitable for retirement annuity funds include:
• Absa’s Newfunds Mapps Growth and Mapps Protect ETFs. These funds have what is known as a strategic asset allocation – that is, they allocate a predetermined amount to each asset class and gain exposure to that asset class by investing in the relevant index.
The Mapps Growth ETF has 75 percent in South African equities (the Swix) and the rest in South African bonds (the SA Government Bond Total Return Index (Govi) and the Barclays/Absa SA Government Inflation-Linked Bond Total Return Index (Ilbi)), and cash.
The Mapps Protect ETF has 40 percent in the Swix, and the rest in the Ilbi, the Govi and cash.
Neither portfolio has any exposure to offshore markets.
• The Satrix Balanced Fund invests 55 percent in three South African equity indices (the Satrix Stable Dividend Index, the S&P Quality Index and the Satrix Momentum Index) and 15 percent in international equities in the MSCI World Index. The rest of the fund tracks bond and inflation-linked bond indices, as well as the FTSE/JSE SA Listed Property Index.
The Satrix Low Equity Balanced Fund invests 25 percent in South African equities (the Swix), 10 percent in global equities (the MSCI World Equity Index) and the rest in bonds, inflation-linked bonds, global bonds, and local and international cash. Its lower equity exposure (below 40 percent) means you should expect it to have a lower return than the Satrix Balanced Fund.
If you are looking for an a multi-asset fund, you should also consider funds such as the Skeleton range offered by Sygnia and the Core funds offered by Nedgroup. You will find the performance of these and other index-tracking funds and ETFs to August 31 in these tables (data provided by etfSA).
An index measures the performance of all the shares in a market, or a sector of a market, such as the industrial or resources sector. If a company represents 10 percent of the value of a market, or a sector of a market, it will make up 10 percent of the index for that market, or sector.
Exchange traded funds (ETFs)track an index, providing you with a cheap way to invest in that index and access a basket of shares. ETFs are listed on the JSE and many are also collective investment schemes.
Exchange traded notes (ETNs) are also listed on the JSE and promise to deliver returns in line with a particular index or a commodity, such as coal or wheat. An ETF has to invest in listed securities, whereas an ETN does not. The ETN provider can invest wherever it likes, as long as it delivers the performance of the index or commodity it is tracking. This means that, when you invest in an ETN, you also have what is known as counterparty risk – the risk of the provider not delivering as promised.
ETFs vs INDEX-TRACKING FUNDS
An index-tracking unit trust fund and an exchange traded fund (ETF) have the following differences:
• Index-tracking unit trusts, like all unit trusts, can be bought from unit trust companies. There is a single management fee and an advice fee if you use a financial adviser.
• ETFs are listed on the JSE and must be bought through stockbrokers, and the costs can be high if you are a small investor, or through investment plans, such as etfSA or Satrix Now. If you use a stockbroker, you will incur brokerage fees, electronic settlement charges and investor protection levies. On a platform, you will have a platform fee and debit order fees. Make sure you check the costs.
• The price at which you buy an ETF is higher than that at which you can sell it – this is known as the buy-sell or bid-offer spread. ETF providers say the spread is narrow, whereas unit trust managers, to promote their index funds, say the spread is wide.
• There may be a difference between the performance of the fund and the index, because unit trusts do not always replicate an index exactly.