Finding institutional support
LEN JORDAAN, head of sales and structuring: Exchange Traded Funds (ETFs) at Stanlib, says the past two years has seen the interest peak in ETFs, or passive, indexlinked funds, as they have started to find favour with the institutional market. He says it is primarily the low costs of ETFs that are finding favour in this environment of single-digit returns where every percentage point is watched like a hawk.
“In this environment, fund managers want to keep costs down, and passive investing does that. Furthermore, you can buy almost any type of product in the passive arena now, so it can replicate almost anything that an active strategy could,” says Jordaan.
We are still well behind the volumes in global terms, according to the Blackrock ETP Landscape Report. The numbers are staggering – global flows into Exchange Traded Products totaled around US$330bn in 2014, with a further US$104bn flowing YTD April 2015. Jenny Albrecht, a CFA and portfolio manager at ETF specialist house Satrix says the passive trend in South Africa is certainly picking up “and while we still have some way to go, the direction is definitely positive in Satrix’s experience. Over the last two years in particular we have seen significant growth from both institutional and retail investors”.
Albrecht says: “Passive investing is no longer just about tracking a large market cap weighted index in order to realise inflation beating returns. The decision as to which index to track is an active choice. No longer does an index tracker track only a market cap weighted index, but any market factor or differentially weighted or scored index can also be tracked to realise a myriad of performance drivers in any market. Within each index segment, ‘traditional vanilla’ or ‘smart beta’, lie a wide range of index choices.” In addition, she welcomes the entry of S&P Dow Jones as an index provider in South Africa “as it has added to the breadth of listed index options available for tracking”.
Once an investor has made the index choice, they need to find an index-tracking product which can deliver the performance of that index. Just as the list of available indices has expanded, so have the index tracking fund options, she says.
There is no difference in the underlying portfolio of the ETF or IT-UT (index tracking unit trust) tracking, for example, the FTSE/JSE ALSI 40 index.
Both will fully replicate the index by holding all the index constituents in exactly the same weights as the index. Both vehicles are governed by the CISCA and are highly regulated. Both are transparent. Both are liquid. “The ETF, as the name implies, is listed and traded on the stock exchange like any other company share, for example MTN or Sasol. It is therefore subject to JSE listing requirements. It is priced continuously throughout the trading day.
The IT-UT is priced once a day and traded via the Unit Trust Management Company (Manco). If you are a long term investor this pricing frequency should not matter to you.
“The ETF, by virtue of its listing, is subject to the JSE settle- ment cycle for equities, which is currently five trading days. When redeeming an ETF investment your proceeds will therefore be received a few days later than when redeeming an IT-UT.
Note this is no reflection on the liquidity of the ETF investment.”
Albrecht explains that any ETF is required to publish its holdings daily. “The IT-UT does not have this requirement as unit trust regulation only specifies a quarterly reveal of holdings. This does not mean the transparency of the IT-UT is in question. As unit trusts have traditionally been actively managed funds, the quarterly publication of holdings is reasonable as an active manager would of course not want to reveal his positions daily. As mentioned, the product reflects the index and since index data is continuously available, effectively so is the IT-UT data.
“Furthermore, the cost of the ETF and IT-UT product is virtually the same. However, additional access costs will make a difference to the total costs. To make an informed decision on costs, review the cost of any platform, LISP, online trading facility or stockbroking account and add this to the product cost. In addition the cost of a financial advisor must be considered, if one is used.”
The product you require may not be available in both ETF and IT-UT format. For example Satrix currently offers sector trackers (Resi 10, Fini 15, Indi25) in ETF format only. Satrix Alsi40, Dividend Plus and Rafi 40 are available in both ETF and IT-UT format, while Property and Balanced tracker funds are available as IT-UTs.
“The performance of an ETF and IT-UT tracking the same index and which has the same fee should be similar. However, differences can occur mainly due to cash flows and fund size. IT-UT cash flows take place in the fund, causing additional trading and custodian costs which can affect performance,” says Albrecht.
Cash flows within the ETF are managed by the buying and selling of ETF securities in the secondary market. Here an additional bid-offer spread must be considered. In the passive arena most ETFs have been prevalent for longer than their IT-UT equivalents – they therefore tend to have bigger market values, having had more time to gather assets. Fund size matters and a smaller IT-UT (specifically in the start-up year) will usually be more prone to tracking error as fixed costs and cash flows are a larger percentage of fund size. However as funds gather assets and ETF and IT-UT fund sizes converge over time, this size issue will become less relevant.
“Whether you choose an ETF or IT-UT as your passive investment vehicle should depend on the reasons outlined above. Your individual circumstance will dictate the best route for your investment needs and the choice may simply be a matter of personal preference. Either way, you will realise your goal of achieving returns as close as possible to that of your chosen index.
How does the performance of index-tracking funds compare to their actively managed counterparts? Albrecht says it is a fact that the average active manager underperforms the index.
Using 10 years of Morningstar data up to end May 2015, 74 percent of the retail class of unit trusts in the SA Equity General category underperformed the FTSE/JSE All Share Index, while a staggering 91 percent underperformed the often preferred FTSE/JSE SWIX index. “Find- ing the small percentage of active managers who will perform in the top decile into the future becomes a difficult task for an investor,” she adds.
“We all know the standard disclaimer that past performance is no indication of future performance. Yet we typically pick the current winners believing that a repeat stellar performance must certainly be on the cards. But of course the trick is to pick the winners before they win the awards, so that you can actually participate in that performance,” says Albrecht.
She adds that Satrix has performed a research exercise on the number of times you would need to change your fund choice to consistently be invested in the top five performing funds. Over the 19 year review period the answer was a staggering 80 times.
“Would you have known which fund to pick and would you have been able to do it at exactly the right time? Or would you have been better off invested in the index, with the added benefit of a lower cost – the statistics speak for themselves,” she questions.