The in thing
But investors must understand what they’re buying
EXCHANGE-TRADED NOTES (ETNS) are fast becoming one of the most popular new investment tools being rolled out by financial institutions trying to capture market share in South Africa. However, investors need to be sure of understanding exactly what they’re getting.
Most investors who have dabbled with the stock market understand what an ETF is and most will have some understanding of how a product range such as Satrix works. But as market awareness grows about passive products, investors need to ensure they understand what they’re actually buying. For example, take Standard Bank’s recently launched Africa Equity ETN. While the portfolio itself gives investors access to 100 plus companies in a basket of African countries, the ETN isn’t backed by physical equity but rather Standard Bank’s promise to pay investors the equivalent of what it calculates the basket to be worth.
The retail investor can never physically redeem the basket for its underlying components. That has pros and cons for investors. For instance, the recently launched Deutsche Bank ETN products that give investors access to China, Africa and an emerging market “basket”. Kari van Rensburg, director of global equity derivatives at Deutsche Securities, says these products will offer retail investors access to passive products on a very low fee base (85 basis points). The fees are lower for an ETN than an ETF product, as they’re classified as different types of products and have lower regulatory costs attached to them.
That cost factor has been a criticism levelled at the traditional Deutsche Bank X-Tracker products, which are pure ETFs. The total expense ratio of the ETF product comes in between 1,10% and 1,25% against 0,85% on the ETN. That has to some degree meant investors have been shy to make use of the products in their portfolio.
However, such behaviour has been changing. “We now have around R1,6bn in assets in the X-Tracker product range and since the start of the year we’ve had about a 50% increase in the units held in the World, US and Japan [index-tracking] products,” says Van Rensburg.
An interesting observation he made was that retail investors were largely making their own investment decisions by investing through online stockbroking offerings rather than through structured investment plans.
While there’s nothing to suggest either Standard or Deutsche Bank products are anything but legitimate offerings, investors should be sure they understand what they’re getting for their money, especially with costs now being such an important selling factor for passive products. That’s likely to become an increasingly relevant topic, with ETNs and leveraged “passive” products on the horizon for local markets.
Deborah Fuhr, of global asset management giant Blackrock, makes an important point in commentary about the Financial Stability Report into some of the new generation exchange-traded products that have been introduced over recent years. “The report perhaps missed a trick in not focusing in more depth on the risks posed by exchange-traded notes and certificates. Certainly it was the realisation that investors had 100% counterparty exposure to AIG that focused many minds in 2008 that, while an ETN might trade and settle like an ETF, it didn’t have the inherent protections you can assume in the latter structure.”
Commenting on whether such concerns were relevant to the South African market, Mike Brown, of etfSA, says: “These concerns aren’t currently strictly applicable to SA, where the Financial Services Board’s regulations prevent the use of derivatives or leveraged (geared) positions in the construction of ETFs. In the case of ETNs, the JSE does allow the use of futures contracts in holding the underlying assets. Such futures contracts, of course, are exchangetraded products subject to daily, mark to market and margin requirements as well as full transparency – but also requires the issuer of the ETN to provide a fully underwritten obligation to deliver the performance of the asset being tracked.”
KARI VAN RENSBURG