Exchange traded funds (ETFs), along with other passive investments, are becoming more popular with local investors. Launched in South Africa in 2000, they’ve gained traction in recent years as investors become more cost conscious as a result of muted market returns over the past few years.
ETFs still make up a much larger portion of the funds invested in markets such as the US than they do in South Africa, so local investors could be missing out on a cost-effective way to gain overall market exposure.
It is argued that developed markets such as the US are more efficient when it comes to pricing - in other words, the prices of the shares have taken into account all factors, present and future, that may affect the price of that share. Some believe this pricing mechanism to be less efficient in developing markets, such as South Africa, hence the tendency to stick with actively managed funds where managers are able to take advantage of any opportunities presented by the market.
ETFs are similar to unit trusts, but are listed on the stock exchange and they typically track a specific index, although commodity ETFs are also available. Because they are listed on an exchange, the price changes throughout the day (as opposed to a unit trust, which has daily pricing) and investors can buy and sell their ETFs throughout the day.
Although it may be difficult for a novice investor to select individual shares, any investor can get started by investing in an index (made up of all the shares listed on that index) and will receive the market return, known as beta, minus a cost.
The mains benefits of investing via an ETF are:
* ETFs tend to have lower costs than actively managed unit trust investments (although passive unit trusts are also available).
* ETFs are highly regulated. In South Africa, ETFs (as well as unit trusts) are governed by the Collective Investment Schemes Control Act. Both ETFs and unit trust funds are monitored by independent trustees and are regulated by the Financial Sector Conduct Authority.
* Investors gain exposure to a number of shares in the index via a single investment, without having to research and invest in each single share.
* Depending on the index chosen, investors gain access to offshore markets via the JSE.
* ETFs are transparent, as investors can readily see the underlying companies that make up the index.
According to Dean de Nysschen, a research and investment analyst at Glacier by Sanlam, ETFs have a place in the portfolios of both novice investors and experienced investors.
Before investing in a particular index - as with any other investment - investors should take into account their time horizon, as well as their ability and capacity to take on risk.
ETFs, like unit trusts, will experience volatility in line with market movements.
Investors should be prepared to invest for at least five years, possibly even seven to 10 years, to see and enjoy real growth.
“Some ETFs - for example, those investing in high-dividend-yielding companies - are better suited to providing income, whereas other ETFs are more suited to growing capital. Due to the increasing number of ETFs available, as well as the introduction of smart beta funds that aim to outperform the index, investors need to carefully consider which index to invest in, aligned with their needs and goals,” he said.
“Investors can now invest in ETFs alongside unit trusts, simplifying access to these investment options. These cost-effective opportunities are available within retirement and discretionary savings portfolios, allowing investors to diversify portfolios and reduce overall cost,” said Roenica Tyson, an investment product manager at Glacier.
Supplied by Glacier Financial Solutions and Sanlam Life Insurance