More offshore funds coming

A big competitor is on the way to SA — how will the locals respond?

lobal flows into exchange traded funds are growing — fast. An estimated $20bn went into trackers last year, increasingly from institutional investors and hedge funds that are replacing futures contracts with ETFs to gain exposure to sectors or markets or as a hedge against market risk.

ETF providers are going head to head with derivatives contracts, offered by the likes of CME exchange group globally and Safex here in SA, as they promote their products as tools for managing investment portfolios.

Unsurprisingly perhaps, SA is slightly behind the curve, partly because of the cost of investing in ETFs here relative to the US and Europe. Liquidity also remains an issue for large institutional investors.

But the market could be in for a shake-up because BlackRock has finally received approval to market a significant number of ETFs and index funds to local investors. It’s the world’s biggest asset manager, with more than $4.5 trillion in assets under management. It’s also the biggest player in the ETF space.

Consilium Securities’ Nick Kunze says for larger institutions to seriously consider using ETFs for market exposure, the market needs to be far more liquid and not subject to a handful of market makers. For smaller hedge funds, says Trofin’s Claudius Rostol, liquidity isn’t as big an issue.

And because these funds don’t just apply long-only strategies, the flexibility they offer is good. Funds can gain exposure to sectors without having to rely on large research teams. This is particularly relevant for offshore exposure. It’s not always the cheapest option, though, with average total expense ratios in the region of 40 basis points, well above the costs you’d pay in more mature markets.

According to a report in the Financial Times, two-thirds of European and three-quarters of US institutions surveyed said an S&P 500 ETF provided more effective beta exposure than an S&P 500 future for a fully funded S&P 500 position. Ease of use and lower costs were the main reasons cited for switching from equity derivatives to ETFs. Globally, ETF fees have fallen dramatically over the years, particularly for less complicated “vanilla” funds.

However, in SA, Rostol says, it’s still far cheaper to trade the Alsi or the Swix on the local equity derivatives market. Spreads on Safex are also much tighter — as little as one or two basis points — compared with as much as 50 to 100 basis points in the ETF market.

Together with costs, those spreads may narrow with BlackRock’s entry. The total expense ratios of BlackRock’s ETFs are significantly lower than those local investors pay. And it’s starting with an expected 26 ETFs and 17 index funds. However, these won’t be listed on the JSE for now, which means you can only access them through an offshore broker. There are also a number of other local options for buying offshore stocks including ETFs, such as Standard Bank’s Webtrader.

BlackRock’s new local offering will grow the range of offshore funds that financial advisers can market to South African investors. They’re aimed very much at the institutional market though. Deutsche’s x-trackers have fulfilled a vital role and will continue to do so for those seeking exposure on a geographical basis. BNP Paribas offers a range of exchange traded notes too, giving regional and global exposure.

What BlackRock is going to offer, though, is sectoral exposure. Infrastructure, water and global property are just a few of the sectors it says it’s planning to offer South African investors. It’s not offering its full suite of ETFs to the South African market though, choosing those that it sees most demand for after canvassing local investors. It has had more than enough time to suss out the market — it opened its local office almost four years ago, so investors could be forgiven for getting a little impatient waiting to sample its offering. This will also include some low-volatility ETFs for investors looking for less volatile returns — and we’ve seen the success Coreshares has had with its LowVolTrax ETF.

It will be interesting to watch market incumbents, including Satrix and Deutsche, to see how quickly they react to BlackRock’s entry — perhaps by cutting prices to remain competitive. This in turn could boost the use of ETFs rather than derivatives contracts, which would only help to increase the depth of the market.

BlackRock’s new local offering will grow the range of offshore funds that financial advisers can market to South African investors