YourMoney Joining the passive investment revolution
Richard Meadows dips a toe into the world of investing in exchange-traded funds.
NEW ZEALAND is finally joining the giant revolution under way in global investing.
For centuries, clever-clogs fund managers have professed to be able to pick the companies or sectors that will do best in any given year. Many studies suggest they’re actually no more accurate than the proverbial monkeys throwing darts.
These days, more than 50 per cent of new investments made in the United States are under ‘‘passive’’ management.
Cash is pouring into exchangetraded funds (ETFs), which offer huge diversification by simply tracking entire markets or sectors.
Compared to active managers charging through the nose, the fees are minimal.
Private Asset Management financial adviser Brent Sheather is a fan of the automated approach.
‘‘The good thing about an ETF is that if they have a great year, the computer doesn’t suddenly say ‘I want a performance fee’,’’ he says.
The local stockmarket operator’s attempt to get ETFs off the ground hasn’t exactly been a roaring success.
NZX’s little-loved range of passive funds have been expensive by global standards, and confined to the Australian and New Zealand markets.
The entire ‘‘Smartshares’’ range has $1 billion invested in it. To put that in perspective, Kiwis have about $144b in bank deposits.
July 29 provided a major breakthrough. The NZX has partnered with US-based passive fund colossus Vanguard, and now offers a range of nine new international ETFs.
It’s a move worthy of congratulation, says Sheather.
His company has been investing directly in Vanguard funds since 1990. While that’s well and good for professionals, it’s been a struggle for small-fry investors to jump through the various hoops.
So are the NZX funds a step forward for the little guy?
PRICING
At first glance, the new ETF fees are still eye-wateringly expensive. The annual management fee for the US500 Trust is 0.3 per cent. That’s six times more expensive than buying into the Vanguard fund directly, at 0.05 per cent.
The other eight funds charge 0.45 per cent, roughly three times more.
However, Consilium accredited investment fiduciary Ben Brinkerhoff says it’s probably not a fair comparison. Vanguard has only been able to offer rock-bottom fees in recent years by building enormous scale, he says.
The NZX is starting from scratch, and should be able to cut costs once it gets enough investors on board.
Aaron Jenkins, NZX’s fund management boss, says the initial interest in the global ETFs has been encouraging, which bodes well for future pricing.
‘‘As we build scale within each of the funds we will review the management fees,’’ he says.
Buying Vanguard units directly in the US also comes with all sorts of extra costs which need to be considered.
Getting a US broker isn’t a problem – local stockbrokers have the hook-ups – but there are foreign exchange fees, brokerage, and custodial fees to contend with.
‘‘Some brokers charge a huge amount of custody fees, which can ruin the whole thing,’’ says Sheather. That ranges from a ‘‘horrendous’’ 0.2 per cent cut of any international funds being held, to a flat fee of $50 or so per stock.
Sheather says for those with a hundred grand to invest, flat fees are not a big deal. ‘‘For people with large amounts, they might still be better to go with Vanguard directly.’’
For smaller mum and dad investors, the NZX funds will probably work out cheaper, but it needs to be worked out on a caseby-case basis, Sheather says.
It’s worth noting that buying ETFs listed on the Australian stock exchange, like those offered by BlackRock, eliminates the custodial fee problem.
LOCAL BENEFITS
There are other advantages to going down the local route.
The NZX’s application fee is $30 for investments of less than $20,000, with a low minimum entry point of just $500.
But the major benefits are being able to drip-feed ongoing savings of as little as $50 a month, and the option to reinvest dividends without paying additional fees or brokerage.
Jenkins points out investors can also contact a familiar voice in New Zealand with any questions or concerns.
TAX
The NZX funds are structured as portfolio investment entities (PIEs).
That removes the headache of dealing with the torturous foreign investment rules that apply to direct investments.
‘‘One of the big advantages with a PIE is there’s no expensive accounting required,’’ says Sheather.
The NZX sorts it all out and investors pay tax at 28 per cent, lower than the top personal rate of 33 per cent.
However, non-PIE foreign investment can have its own advantages.
In simple terms, when the market has performed poorly, you’ll have a good chance of paying no tax at all, even if you received some dividend income.
The trade-offs involved can be complicated and Jenkins suggests taking advice.
DIVERSIFICATION
When it comes to expected returns, Brinkerhoff says there’s probably not much difference between New Zealand companies and international ones.
The idea behind diversifying far and wide is that it allows investors to reduce volatility.
‘‘What that really means in layman’s terms is I’m going to increase my certainty that I’m going to achieve my objectives,’’ says Brinkerhoff. ‘‘That’s a free lunch. You want to eat that.’’
Some years New Zealand companies will do great, and other times international markets will prove to be the best bet.
‘‘I’d be better off 100 per cent in one or the other if I could time that sort of thing, but in all humility, none of us can,’’ Brinkerhoff says.
CURRENCY RISK
Some investors worry that by buying US-denominated funds, they’re exposing themselves to foreign exchange risk if the greenback falls. But in the same vein as the above, this actually provides a natural hedging of one’s bets by diversifying across currencies.
‘‘Perversely, it’s people who don’t invest overseas who have got the foreign exchange risk,’’ says Sheather.
LIQUIDITY
Offloading units in funds that lack scale can be difficult, with a big ‘‘spread’’ between the bid and ask price. ‘‘A designated market maker operates to provide investors confidence that there will be an active buyer and seller of units in each Smartshares fund,’’ Jenkins says.
MORE TO COME
NZX now has 19 different ETFs tracking everything from emerging markets to Australian property.
Jenkins says the company is planning on launching more options this year.
More is not always better. As Sheather points out, Vanguard founder and passive investing pioneer Jack Bogle is less than impressed with the rapidly fragmenting ETF market.
That’s because choosing to be exposed to specific sectors, as opposed to the broadest range of companies possible, can defeat the entire purpose.
BETTER THAN NOTHING?
Sadly, it doesn’t appear the passive fund titans like Blackrock and Vanguard will have a dirtcheap direct offering in New Zealand any time soon.
Brinkerhoff lobbied Vanguard to set up shop here, but its NZX partnership shows that’s not the route it has chosen. The big boys simply aren’t interested in New Zealand, he says. ‘‘They’ve got a trillion dollars. There’s just not enough money here.’’
Nevertheless, Brinkerhoff is congratulating the NZX on its move. ‘‘Good on them for trying. The more competition and the more entrants into the market we have, the better for consumers.’’