Per­for­mance and costs re­garded as im­por­tant fac­tors, writes Pe­dro van Gaalen

Financial Mail - Investors Monthly - - Contents -

Per­for­mance and costs are re­garded as im­por­tant fac­tors

Global growth in ex­change-traded funds (ETFs) con­tin­ues un­abated. Fol­low­ing a strong 2017 per­for­mance, when $662bn was in­vested in pas­sive eq­uity funds glob­ally ac­cord­ing to Morn­ingstar Inc’s 2017 Global As­set Flows Re­port, ex­pec­ta­tions were high that 2018 would de­liver even greater cap­i­tal in­flows.

“Favourable mar­ket con­di­tions across the globe in 2017 at­tracted the great­est flows in more than a decade,” said Kevin McDe­vitt, a se­nior an­a­lyst at Morn­ingstar Inc.

“Ral­ly­ing eq­uity mar­kets, sub­dued volatil­ity and sta­ble in­ter­est rates ap­pear to have lifted in­vestor con­fi­dence world­wide.”

Fig­ures for Q1 2018, re­leased in the ETFGI Global ETF and ETP in­dus­try in­sights re­port, af­firmed the grow­ing dom­i­nance of ETFs in the port­fo­lios of global in­vestors. ETFGI re­ported that a record $4.92tril­lion was in­vested in 7,389 ETFs and other ex­change-traded prod­ucts listed glob­ally dur­ing this pe­riod.

This rep­re­sents growth in as­sets un­der man­age­ment of 1.74% over the quar­ter, and equates to $137bn in net in­flows. Sta­tis­tics from ICI Global cor­rob­o­rate the up­ward trend, show­ing that from Au­gust 2017 to Au­gust 2018, global eq­uity ETF as­sets rose by $74.19bn.

Graeme Well­sted, ex­ec­u­tive di­rec­tor at lo­cal stock ex­change ZAR X, says the con­tin­ued pop­u­lar­ity of ETFs hinges on costs and per­for­mance.

“In gen­eral, ETFs tend to of­fer a lower to­tal ex­pense ra­tio than ac­tively man­aged funds and unit trusts, which makes them a more cost-ef­fec­tive mech­a­nism to gain ex­po­sure to eq­ui­ties.”

Ni­lan Mo­rar, VP of Trad­ing at Pur­ple Group, agrees, say­ing that ac­cess­ing eq­ui­ties through an ETF cre­ates economies of scale that can­not be matched when buy­ing shares in­di­vid­u­ally, due to the bur­den­some ad­min­is­tra­tive re­quire­ments.

“His­tor­i­cally, re­tail in­vestors re­quired sig­nif­i­cant cap­i­tal to open a trad­ing ac­count, which meant the bar­ri­ers to en­try into eq­uity in­vest­ing were re­stric­tive,” he says. “How­ever, on­line trad­ing plat­forms and ETFs now of­fer a more ef­fi­cient and ac­ces­si­ble means to gain broad ex­po­sure to the best-per­form­ing global stocks, all with one cost-ef­fec­tive fee.”

How­ever, Ne­rina Visser, a CFA char­ter holder and di­rec­tor at et­, cau­tions in­vestors against ob­sess­ing over the cost ben­e­fit. She says: “In­vestors of­ten hag­gle over five or 10 ba­sis points on their as­set man­age­ment fees, but there are of­ten more oner­ous costs as­so­ci­ated with in­vest­ing, such as debit-or­der fees. When in­vestors cal­cu­late the to­tal costs as­so­ci­ated with in­vest­ing, a com­pre­hen­sive anal­y­sis should con­sider the en­tire value chain, in­clud­ing ad­min costs, man­age­ment and per­for­mance fees, trans­ac­tion charges and whether div­i­dends are be­ing rein­vested.

“Fix­at­ing on sin­gle charges will fail to un­cover the ar­eas where in­vestors can cre­ate cost ef­fi­cien­cies based on how, where, when and how of­ten they in­vest.”

More sig­nif­i­cantly, Well­sted be­lieves it is the in­abil­ity of many ac­tive fund man­agers to beat bench­mark re­turns from ETFs that is driv­ing growth in th­ese in­vest­ment prod­ucts.

The per­for­mance of ETFs has brought into fo­cus the value in­vestors get in the mar­ket, which is why ac­tive fund man­agers now need to jus­tify their per­for­mance fees.

Visser says there are ad­di­tional fac­tors be­hind the con- tin­ued rise in ETF pop­u­lar­ity. “The col­lapse of Stein­hoff … sent many fund man­agers and in­vestors scram­bling to ac­cu­rately as­sess their ex­po­sure, which brought the is­sue of in­vest­ment trans­parency into pop­u­lar in­vestor dis­course.”

She says ETFs of­fer a de­gree of trans­parency that a grow­ing num­ber of in­vestors are af­ter, par­tic­u­larly amid a rise in in­vestor ac­tivism. “It is sim­ple for in­vestors to de­ter­mine ex­actly what they are in­vested in within an ETF, whereas the com­po­si­tion of other types of funds can be more com­plex.”

In ad­di­tion, the Na­tional Trea­sury’s in­vest­ment frame­work, which aims to drive greater in­clu­sion, is help­ing to pro­mote a shift to­wards pas­sive in­vest­ments like in­dex­track­ing ETF op­tions. ETFs have had sig­nif­i­cant growth in re­cent years due to the need to di­ver­sify mar­ket risk in a sin­gle ve­hi­cle, as they of­fer ac­cess to a grow­ing range of prod­ucts that de­liver ex­po­sure to un­der­ly­ing as­sets and global mar­kets.

This mar­ket evo­lu­tion has brought about a new gen­er­a­tion of ETFs, which Visser be­lieves will con­tinue to fuel growth. “A grow­ing num­ber of in­vestors are look­ing to lever­age fac­tor-based or smart beta ETFs, for ex­am­ple, which have proven to pro­vide good re­turns in dif­fer­ent mar­ket cy­cles. This of­fers in­vestors more tar­geted ex­po­sure through ETFs, where they can hunt for mar­ket-beat­ing re­turns against tra­di­tional cap-weighted in­dex-linked strate­gies.”

Given the strength of the fun­da­men­tal driv­ers at play, the mar­ket re­mains bullish on ETFs. Some com­men­ta­tors pre­dict that as­sets un­der man­age­ment in ETFs will reach $25-tril­lion glob­ally by 2025.

Ni­lan Mo­rar … economies of scale

Graeme Well­sted … ETFs cost-ef­fec­tive

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