Internationally, and in South Africa, investment in exchange-traded funds (ETFs) is increasing, and imaginative developers of indices and the ETFs that track them are continually creating interesting new products.
One that draws quite a lot of attention is the impressive-sounding S&P500 Quality, Value & Momentum Multi-Factor Index, which combines three index themes: quality, which is based on financial health; value stocks, comprising good shares that are temporarily cheap; and momentum stocks, representing strong-running shares.
An important reason for the interest shown in this newbie is that backtesting from 1994 to 2017 shows that it would have outperformed the S&P500 Index by close on 91%.
During this period, the S&P500 would have earned an average of 5.5%, while the S&P500 Quality, Value & Momentum Multi-Factor would have yielded 10.5%.
Global investment in the S&P500, which represents the 500 biggest companies in the US, is very popular, and this ETF, which was created by S&P Dow Jones Indices, is offered as an interesting refinement.
Because the performance of the Multi-Factor Index, which is backed by research, is so much better than that of the S&P500 Index, it’s obvious that investors will support the newbie, especially as investors who are turning increasingly to ETFs because relatively few actively managed ordinary unit trusts succeed in outperforming the index.
The Multi-Factor Index has the advantage that the underlying mixture of indices on which it is based, reduces volatility (confirmed through research) because the indices or ‘factors’ have a limited correlation with one another. It therefore also reduces risk.
There are times that value shares are popular, so that an investment in a value ETF can beat the general market because value indices outperform.
At other times, momentum could be the driver and then value funds lag behind.
The big difference is of course that an ETF simply tracks an index – varying from the general index to a resources index (Resi) – while in the case of a unit trust, fund managers would select those shares that they believe show the best value or profit prospects.
With the new product, a mixture of various indices is offered, which are then tracked passively.
The costs are also lower as in the case of unit trusts, as the managers does not have to use their discretion regarding which shares appear in an index. They simply track the indices.
SA’s oldest ETF is the Satrix 40, which made its appearance in 2000. It tracks the FTSE/JSE Top 40 Index, which cannot offer an investor more than the performance of the heavyweights on the exchange.
The Top 40, as well as the All Share Index, are based on market caps, which means that a group such as Naspers*, with a market cap of R1.46tn, has far more weight than a large bank such as FirstRand, with a market cap of R342bn.
All that these general indices therefore offer is the performance of the market, which is not to be sneezed at as such a wide spread of shares, especially from a risk point of view, offers greater security.
The collapse of a Steinhoff will not ruin you! In fact, Warren Buffett, who is regarded as the world’s most successful share investor, advises the ordinary investor “to buy the market”, in other words, to invest in a general index.
Since the advent of the Satrix 40, a whole variety of ETFs has been added in SA, varying from one that tracks the property index (Sapi) to the industrial index (the Indi25) and the Govi, an index for government bonds.
Investors need not invest directly in an ETF as some management companies offer units trusts that track certain indices at relatively lower costs than an ordinary unit trust. In this case, certain facilities are available, such as investing through a monthly debit order.
Locally, some investors prefer an ETF such as the Satrix Equally Weighted Top 40. It’s a refinement of the JSE’s Top 40.
All 40 shares enjoy equal weighting in contrast to, for example, the major weighting of Naspers and the international brewer, AB InBev, the biggest company on the JSE.
In SA, the NewFunds SA Equity Premia Range is available, which is also aimed at reducing risk, but at the same time aims to outperform the general market.
It offers ETFs such as the Low Volatility ETF, which selects 20 shares according to set requirements such as the level of standard deviation; and then we have the Equity Value, which is based on 30 shares with the lowest price-to-earnings multiple, as well as price-to-book ratio, and thirdly, the Momentum-ETF, which is based on the 20 shares that increased the most over the past 12 months.
Lucas de Lange is a former editor of finweek and the author of two books on investment.
*finweek is a publication of Media24, a subsidiary of Naspers.