How to make ETFs work for your portfolio

Photo: Gallo/Getty Images
Photo: Gallo/Getty Images

The first exchange-traded fund (ETF) was listed on the JSE in 2000. Fast-forward to September 2019 and 78 ETFs are now (at the time of writing) available to local investors, according to Johann Erasmus, who heads up index funds at Standard Bank. 

At the end of June 2019, the total market capitalisation of all JSE-listed ETFs in SA amounted to R81bn, according to data from etfSA.

Attractive to investors has been the ability to invest closely to specific indices, without having to pay an active manager or pick shares. ETFs are also often seen as cheaper than using an active investment management approach and have become popular as local investors became more and more familiar with these passive investment vehicles.

Can one build a diversified portfolio using only ETFs?

“ETFs provide excellent diversification, as each ETF typically represents an index, comprising an entire basket of stocks or instruments. By combining a few ETFs representing different asset classes, sectors, and geographical regions, it is very easy to build a completely diversified, low-cost portfolio,” affirms Nikolay Mladenov, fund manager in the Ashburton Investments indexation team. “You could build a balanced portfolio with exposure to local and offshore assets, with the weightings dependent on your view of markets and risk tolerance.” 

For example, Ashburton has a JSE Top40 ETF, a Mid-Cap ETF for exposure to local equity, an Inflation ETF for exposure to local fixed income, the Global 1200 ETF for exposure to offshore equity and the WGBI (World Government Bond Index) ETF for exposure to global bonds, while Satrix has a property ETF for local property exposure and Absa’s New Gold ETF for exposure to gold, among many others.

“As always in these matters,” says Iain Anderson, head of investments at Sygnia, “every individual’s circumstances will determine what a suitably diversified portfolio entails, but there are excellent options to build a low-cost portfolio of domestic and international equities using domestic-listed ETFs.”

Each individual investor’s personal circumstances or goals differ, and you can only construct a proper portfolio of this kind by taking all of this into consideration as it would require different allocations in the underlying asset classes and jurisdictions to adequately meet specific needs.

“Get some good financial advice or guidance, be it via a financial or robo-adviser, around your personal situation and what your ideal portfolio should look like,” says Erasmus. He emphasises spending more time to financially educate yourself because, at the end of the day, “it remains your investment decision and you work hard for your money”.

Are ETFs really cheaper?

ETFs are well-regulated by the JSE and Financial Sector Conduct Authority (FSCA), and the expenses that are allowed in an ETF are standardised to include fees such as management fees, bank charges and audit fees, explains Mladenov.

These fees would then comprise the total expense ratio (TER). 

The transaction cost of buying and selling the fund’s underlying assets would be added to the TER to provide a total investment charge (TIC) for the fund. Cost of access should also be considered when investing in ETFs. These include brokerage or platform fees charged by the service provider that is giving you access to the ETFs.

Most ETFs in SA at present cost less than 1% (of funds invested), according to Eugene Visagie, portfolio specialist at SA’s Morningstar Investment Management office. 

“Large indices to track are normally cheaper than more non-vanilla products. As an example, to buy a product that tracks the JSE Top40 comes in at ten basis points (because it is a large index with lots of liquidity and relative ease to implement) compared to an emerging market index that costs 40 basis points,” he explains. 

Erasmus also mentions advice costs. 

“If one does not follow the DIY approach, these could be in the form of traditional financial adviser fees or guide advice fees through a robo-advising tool,” he says. 

Cloud Atlas Investing’s team cautions that anything more than 3% would most probably be too high.

It’s also worth noting whether the ETF is a normal, locally managed fund, or a feeder ETF. 

Investment expert Simon Brown’s financial education platform uses the example of Satrix’s feeder ETF products (like the Satrix Nasdaq 100 or S&P 500 feeder ETFs). “Satrix’s offshore products outsource this process of buying and selling shares to mirror the index to another ETF provider. They do this because the ETF provider they feed into can do all this mirroring business at a much lower rate than Satrix can.”

As more products come to market, and clients become more cost-conscious, more pressure will be placed on these offerings, says Visagie.

Choosing an ETF

“ETFs are only wrappers (think of it like a vessel),” explains Erasmus. 

It’s the performance of the underlying asset classes that drive performance. 

The Standard Bank rhodium ETF, has, for instance, been the best-performing commodity ETF over the last two-and-a-half years; the performance driven by the price of rhodium and the rand-dollar exchange rate, with the Standard Bank palladium ETF also performing well, mentions Erasmus. 

The performance of an ETF is highly dependent on the performance of the underlying investments in the ETF. Over the past ten years in SA, this has been found in US equities and industrial shares listed on the JSE, notes Nerina Visser, ETF strategist and adviser at etfSA. 

“Apart from the performance of the underlying assets, the best-performing ETFs would have relatively low costs, exhibit very good index-tracking management, have efficient market making [continued and efficient exchange between buyers and sellers] and will be offered by an ETF issuer with strong operational capabilities.”

Inasmuch as past performance is no indication of future performance, ETFs that track international assets have generally been best performers and featured more in the responses of most industry experts on ETFs regarding which ETFs are best for diversifying one’s investment portfolio (more specifically to gain global exposure).

ETFs that track the S&P 500 index – which measures the stock performance of the 500 largest companies listed on stock exchanges in the US – have been best performers as a result of the underlying assets, i.e. US equities. The S&P 500 has, on average, fallen only in three months, with September proving to be the index’s worst month of the year, according to Dow Jones Market Data. 

The US’s economic expansion is now the longest in history, says Francois van der Merwe, portfolio manager at Absa Multi-Management. “The US president can move markets with a tweet, de-globalisation is taking hold, populism is rising, and a record amount of global bonds are trading at negative yield.

“Stocks, especially in the US, are up double digits for the year-to-date and trading at eye-watering lofty valuation levels on the back of buoyant investor sentiment and interest rate cut expectations,” he says.

The monthly performance survey of index-tracking ETFs with global exposure for the period ended 31 July 2019 is evidence of the strong performance witnessed from local S&P 500-focused ETFs.

This is a shortened version of an article that originally appeared in the 26 September edition of finweek magazine. Buy and download the magazine here or subscribe to our newsletter here

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