Strive for bal­ance

A cap-weighted top 40 in­dex tracker can act as a strong base to which riskier in­vest­ments can be added, writes Pe­dro van Gaalen

Financial Mail - Investors Monthly - - Feature — Etfs -

M ul­ti­ple fac­tors have fu­elled the sus­tained growth of ex­change-traded funds (ETFs). Pri­mary among th­ese is the need for a solid foun­da­tion on which to build a bal­anced in­vest­ment port­fo­lio.

Amid ris­ing global risks due to trade wars, the im­pact of Brexit, cur­rency volatil­ity, oil­fu­elled in­fla­tion­ary pres­sure and geopo­lit­i­cal in­sta­bil­ity, in­vestors have sought the sta­ble re­turns of pas­sive cap­weighted ETFs as a core el­e­ment of their port­fo­lios. This pur­pose has en­trenched th­ese in­vest­ment in­stru­ments as pre­ferred long-term ve­hi­cles among many in­vestors.

“ETFs are be­com­ing in­creas­ingly im­por­tant in the con­struc­tion of a bal­anced fund. An ETF is eas­ily ac­ces­si­ble through bro­ker lines al­ready in place and pro­vides ac­cess to a wide range of in­vest­ment op­por­tu­ni­ties,” says Steven Empe­do­cles, port­fo­lio man­ager at Syg­nia.

“Choos­ing the right ETF can pro­vide a well-di­ver­si­fied port­fo­lio of as­sets to re­move un­sys­tem­atic risk, at low cost, and [ETFs] are liq­uid enough to im­ple­ment tac­ti­cal as­set al­lo­ca­tions. As­set man­agers are also cre­at­ing ETFs in more di­ver­si­fied as­set classes to as­sist in cre­at­ing bal­anced port­fo­lios.”

With such a wide se­lec­tion of op­tions to choose from — SA has 90 JSE-listed ETFs/ETNs, ac­cord­ing to fig­ures from et­fSA.co.za — in­vestors need to make in­formed de­ci­sions when se­lect­ing the ap­pro­pri­ate ETF and de­ter­min­ing how funds are al­lo­cated in their port­fo­lios.

Se­lect­ing a cap-weighted top 40 in­dex tracker, which of­fers ex­po­sure to the top 40 largest com­pa­nies listed on an ex­change, re­mains a pru­dent means to cre­ate a risk-bal­anced base that of­fers solid re­turns. ETFs that of­fer higher re­turns can then be added to di­ver­sify the port­fo­lio.

Based on the re­sults of the “Monthly et­fSA.co.za South African ETF, ETN & Unit Trust In­dex Track­ing Per­for­mance Sur­vey” for the pe­riod ended Septem­ber 28 2018, et­fSA.co.za MD Mike Brown ex­plains that for pe­ri­ods of three years or less, com­mod­ity-based ETFs have dom­i­nated the per­for­mance ta­bles, par­tic­u­larly those elated to the scarcer plat­inum group me­tals such as rhodium. This would make th­ese ETFs a suit­able ad­junct to a top 40 tracker, for ex­am­ple.

How­ever, though se­lect­ing the best-per­form­ing ETFs is vi­tal for de­liv­er­ing re­turns, buy­ing sev­eral ETFs does not nec­es­sar­ily pro­vide in­vestors with ad­e­quate di­ver­si­fi­ca­tion, says Chan­tal Marx, head of re­search at FNB Wealth and In­vest­ments. “For ex­am­ple, if an SA in­vestor buys the Ash­bur­ton Top 40, the Sa­trix Indi, the Sa­trix Swix and The NewFunds Mapps Growth ETF in equal weight, he or she will still end up with ap­prox­i­mately a 25% weight­ing in Naspers. The di­ver­si­fi­ca­tion ben­e­fit of adding ETFs to your port­fo­lio is there­fore very much a func­tion of which ETFs you are adding.”

In­vestors can im­prove di­ver­si­fi­ca­tion in their ETF port­fo­lios by eval­u­at­ing fund fact sheets and in­vest­ing across strate­gies, as­set classes, ge­ogra­phies and sec­tors. “By com­bin­ing an ETF that tracks the JSE with those that track a va­ri­ety of as­sets and sec­tors, such as off­shore prop­erty, African eq­ui­ties or hi-tech stocks, you are re­duc­ing risk in your port­fo­lio,” says Marx.

Charles Sav­age, CEO at Pur- ple Group, adds that con­cen­tra­tion risk would be less of a con­cern for in­vestors if their port­fo­lio in­cluded more ETFs that of­fered in­ter­na­tional ex­po­sure. “Lo­cal is­suers have sig­nif­i­cantly in­creased their in­ter­na­tional track­ing, which has given SA in­vestors bet­ter choices and has added sig­nif­i­cant value.”

This ac­cess to in­ter­na­tional ex­po­sure has helped to de­liver good re­turns for ETF in­vestors at a time when the JSE has strug­gled to per­form due to po­lit­i­cal in­sta­bil­ity and rand weak­ness against ma­jor cur­ren­cies. As a case in point, the Septem­ber 2018 et­fSA.co.za per­for­mance sur­vey notes that off­shore eq­uity ETFs, no­tably the Syg­nia Itrix MSCI USA ETF, top the per­for­mance ta­bles for re­turns over long-term pe­ri­ods, de­liv­er­ing an av­er­age of 20.43% a year over five years and 16.54% over 10 years.

By buy­ing into a larger global ETF provider, in­vestors will also ben­e­fit from economies of scale, which en­ables global di­ver­si­fi­ca­tion at a low cost, adds Empe­do­cles.

“How­ever, when in­vest­ing in global ETFs, in­vestors must be aware of what they are in­vest­ing in and how th­ese ETFs are con­structed, be­cause many global ETFs use de­riv­a­tive con­tracts.

“Th­ese pose risks such as coun­ter­party risk, which es­ca­lates in mar­ket tur­moil. This struc­ture is also more ex­pen­sive to run in the long term.”

Choos­ing the right ETF can pro­vide a well-di­ver­si­fied port­fo­lio of as­sets to re­move un­sys­tem­atic risk

Chan­tal Marx … make wise choices

Steven Empe­do­cles … ex­am­ine the risk

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