A starting point to investing

2011-02-12 09:21

When you invest in shares you want to build up a portfolio of shares so that your money is not all tied up in the fortunes of one company.

In order to have a diversified portfolio of at least 10 shares, you would have to start with at least R30 000 to R50 000.

Because of the costs of buying and selling shares, it doesn’t make financial sense to buy shares in one company for less than R3 000.

So if you are starting off with R5 000 for example, it can take you a while before you have built up a sizeable portfolio.

For investors who want to build up a portfolio but need to save until they have sufficient funds, stock brokers recommend investing in exchange traded funds (ETFs). By buying just one share, the investor has exposure to at least 20 shares on the JSE.

Exchange traded funds are investment funds listed on a stock exchange that tracks a particular index of shares. For example, if you invested in an ETF called Satrix 40, you would effectively be invested in the JSE’s top 40 shares. This would include companies like AngloAmerican, British American Tobacco and MTN for example. Therefore, a single purchase of an ETF exposes the investor to a diversified basket of shares. With an ETF, unlike other financial instruments like futures or warrants, you actually own the shares in the underlying companies.

Buying exposure to a basket of shares is much less risky than buying a single listed company share. You, the investor, are exposed to a good spread of large South African companies, so you literally haven’t put all your eggs in one basket.

ETFs in South Africa cover not only equities but also other asset classes, such as gold, bonds and property. So you could actually invest across many asset classes to diversify your investments further.

ETFs track an index of the most liquid shares on the market, which are often the most successful companies on the exchange. A liquid share means one that can be bought and sold easily. This is usually true of large companies that investors want to have in their portfolios.

ETFs have lower fees because they are not actively managed by a fund manager. A fund manager picks shares, for better or worse, but ETFs simply track indices passively by holding the same shares that are in the index.

A further interesting fact is that the majority of active fund managers actually underperform the average of the stock market after costs.

According to Brett Landman, chief executive of Satrix, the recent credit crisis “led investors to question whether active managers could do better than the market in a downturn. The myth has always been that they could, but the credit crisis has sorely disillusioned them.”

There is a growing range of exchange traded funds in the market and this can make it a bit more complicated to select one.

However, a good starting point is Satrix, which is owned by the JSE. It has been around for the longest and is the most well-known.

For the investor that is starting off, the Satrix 40 or the Satrix RAFI would be good starting points. The other indices are more sector-specific and provide exposure to only one sector like resources or financial services. These are used when the investor wants to take a view on a specific industry like financial services or mining for example.

Most investors who simply want equity exposure usually opt for the Satrix 40 which offers diversified exposure across companies and sectors and is invested in South Africa’s 40 largest companies. It tracks the FTSE/JSE Top 40 index.

Most indices are based on market capitalisation (market cap), which means investment in the largest listed share companies. The market cap of a company is based on its share price multiplied by the number of shares in issue.

These traditional indices are still the most popular because they are the most liquid and tend to be used as benchmarks for other funds.

There is, however, a concern in South Africa given the size of our mining companies, that the top 40 index has a lot of exposure to mining – more than 40% of Satrix 40.

Therefore some investors opt for ETFs which follow the SWIX index or ETFs which allocate the same percentage to all the top 40 shares (see sidebar).

The one problem with a fund that invests based on market cap is that the more expensive the company becomes, the more shares you have in the company.

Some investors prefer to invest in companies that are under-priced and are showing value. The idea is that under-valued companies will increase in price more rapidly than companies priced at fair value or over-priced.

While the market cap methodology can give preference to expensive shares, the RAFI methodology doesn’t rely on size so it aims to avoid overweighting over-valued shares.

RAFI stands for Research Affiliates Fundamental Indexation. Research Affiliates is a California-based financial services company that has registered a worldwide patent for fundamental indexation.

The methodology looks at company fundamentals such as sales, cash flow, book value and dividends when including companies in the index (the FTSE/JSE RAFI 40 index is made up of the top 40 companies based on this method) rather than including the company based purely on size. About 150 companies are analysed to include in the basket of 40 shares. Satrix RAFI has 35% exposure to mining.

Helena Conradie, head of Sanlam Investment Management’s (SIM) equity index tracking business, sim.smartcore, says the RAFI is part of a new breed of smart beta products.

“Investors are looking for superior outperformance with lower fees. By investing in smart beta indices, investors can access smarter trackers that are more cost-effective than active management funds,” she says.

You can also invest in the RAFI through the unit trust Old Mutual Umbono RAFI. Plexus and Absa offer enhanced eRAFI options which give you an additional valuation method when selecting the shares.

The Dividend Plus Index is also a “smart index”. It pays quarterly dividends, which can be a good option for investors looking for income and not just capital growth. This index invests in companies with high-dividend yields. The index is made up of the top 30 companies based on what analysts believe their dividends will be over the next year. (See sidebar on dividends as income) If you are looking for capital growth and a relatively higher dividend yield (income), then the Satrix Divi could be a good option.

ETFs have a low-cost structure, which has made them popular with investors. Although costs vary according to the fund, the average management fee is about 0.45% a year compared to up to 2% for a unit trust.

However, there are additional costs depending on how you invest:
Stock broker: As exchange traded funds are listed on the JSE, you can buy them through a stockbroker. This could be a good option if your aim is to build up your own share portfolio.

Brokerages have different pricing models but you need to find out about the minimum fee and the monthly fee.

Online brokers are usually more cost effective. However, you can expect to pay at least R50 each time you purchase an ETF and then the monthly administration fee is about R17 to R50. At these fees you need to invest at least R5 000 to be cost effective. (Next week we will look at the various stockbroking options).

Investment plan: You can invest through an investment plan. Satrix offers an investment plan so does the Exchange Traded Funds South Africa (etfsa). You can invest a lump sum or by way of a monthly debit order. There is a yearly administration fee of 0.8% – although this decreases to 0.45% depending on the amount invested.

If you have a debit order, there is an additional debit order fee charged by the bank. It tends to be less expensive to inves

t through the investment plan for smaller investment amounts because of the higher brokerage charged by stock brokers for these smaller amounts.

However, if this is a starting point for your share portfolio then starting a relationship with a stockbroker may make more sense even if it is more expensive initially.

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