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KUALA LUMPUR: Exchange-traded funds (ETFs) are alternative investment instruments that provide investors convenience, transparency and cost effectiveness, said Hon Cheung, the Asia-Pacific regional director for the Official Institutions Group.
He said investors could easily trade in ETFs as they could “buy and sell like any other shares” without the need to select a specific fund or fund manager.
“Malaysian investors, like those in the US and Europe, are always looking for choices,” Cheung said.
Since the cost was uniform for both retail and institutional investors, ETFs provided an avenue for retail investors “to get an institutionalised product but at a retail size,” he said.
To make ETFs successful, size and liquidity are two important factors.
“Size does count. It gives a higher degree of comfort to investors on the importance of ETFs,” Cheung said, adding that liquidity, on the other hand, was a form of incentive for brokers to trade.
He said the proposal to introduce an ETF comprising stakes pared down by government-linked investment companies (GLIC) would be a “catalyst” for the take off of such funds.
He cited the Hong Kong Tracker Fund as an example of GLIC-related ETF that had attracted retail investors.
“The Hong Kong Tracker Fund was created in an IPO (initial public offering) launch and offered at a discount to its RNAV (revised net asset value),” he said.
ETFs could track the benchmark index, or certain growth sectors, or even Islamic finance.
The diversity of ETFs would be driven by investors’ appetite, Cheung said, adding that investor education would help deepen the market for ETFs.
THE Government is committed to floating at least one exchange traded fund (ETF) on Bursa Malaysia by year-end to aid its plan to gradually sell down shares in state-owned firms, Deputy Finance Minister Datuk Dr Awang Adek Hussin said.
"We are now in the process of formalising the introduction of these ETFs. There is a lot of preparatory work involved," Awang Adek said in Kuala Lumpur yesterday, adding that the Government is serious and committed to the creation of these funds.
Prime Minister Datuk Seri Abdullah Ahmad Badawi had in March announced plans to set up ETFs with a collective fund size of RM3.5 billion, which will be listed on the domestic stock exchange before year-end.
The government-linked investment companies (GLICs) are expected to participate in these ETFs by selling a portion of their portfolios in exchange for units in the ETFs.
The plan is aimed at boosting liquidity and promoting greater retail participation in the stock market, thus providing a vehicle for GLICs to sell down their portfolios in a systematic manner.
At the ministry level, Awang Adek said two joint working groups - headed by Second Finance Minister Tan Sri Nor Mohamed Yakcop and himself respectively - were formed to ensure the successful launching of these ETFs. Both the working groups are made up of the top management from the GLICs, policymakers and regulators.
"We are working together and are meeting regularly, in every two weeks, to help launch at least one ETF before the year-end target as set by the Prime Minister," Awang Adek said.
The minister was speaking to reporters after launching the prospectus of Malaysia's first equity exchange traded fund, which will be issued by AmInvestment Bank Group.
HEAVY investments will have to be made to educate investors about exchange traded funds (ETFs) in order to get that market going in Asia, says a global expert on ETF.
"I think there is a view in Asia that if you build ETFs, investors will come. That's not the case, as we've seen in the US and Europe. You need to spend millions in investor education," said Mark Talbot, chief executive officer of Barclays Global Investors Asia ex-Japan.
Barclays is currently the world's largest ETF provider with US$320 billion (RM1.1 trillion) of assets under management and a 53 per cent share of the global ETF market.
In Asia, he said, a lack of investor education and subdued market-making has resulted in poor awareness and low trading volume of ETFs.
He said one of the reasons for the remarkable 63.3 per cent growth in ETF assets in Europe last year was the emergence of strong players that went all out to educate investors on ETFs. That year, 108 new ETFs were launched in Europe.
The US, however, is still the main driver for global ETF growth. It had 343 ETF listings and US$407 billion (RM1.4 trillion) in ETF assets as at the end of 2006. The ETF market grew by 35.9 per cent that year.
"Interestingly, institutional funds and hedge funds are some of the biggest users of ETFs, although people typically think of it as a retail product," he told participants of the ETF Conference in Kuala Lumpur yesterday.
An ETF is essentially a unit trust fund, except that it is traded on a stock exchange. It represents a basket of securities and is designed to track the performance of an index. The performance of an ETF usually mirrors that of the index it tracks.
Take the FBM30etf as example. Since it tracks the FBM30, it will buy the index's constituent stocks. The number of shares bought for each stock will be based on its weightage on the index.
Q: What benefits does an ETF bring to investors?
Unlike unit trust funds, investors can buy and sell units of an ETF at anytime during trading hours like trading a stock. An ETF is traded in blocks of 100 units.
Instead of buying shares of each and every stock, ETF allows investors to gain exposure to a basket of securities with just a single purchase of ETF units. ETF offers portfolio diversification like unit trust funds.
ETF incurs low management fee as a result of passive management. Transaction cost is low (0.6% via brokerage) compared with unit trust fund (3% to 5% sales charge).
Q: How do I buy or sell ETF?
Like ordinary stocks, you can buy or sell ETF through your broker.
Q: How is the market price of an ETF determined?
As an ETF is traded like a stock, the price of each unit is determined by the supply and demand of the market, and in general, will be traded closely to the market value of the underlying basket of securities.
Q: How do I value an ETF?
An ETF is valued according to its net asset value (NAV). NAV is the fund's assets minus its liabilities divided by the number of outstanding shares. At the end of each trading day, the NAV will be calculated. The increase in NAV means the increase in the value of one's holdings.
Investors should also look at whether an ETF is traded at a premium or discount to the index it tracks.
Q: Does an ETF pay dividends?
Most ETFs do pay dividends. However, investors should study the prospectus of the particular ETF on its dividend policy.
Local investors will soon have the option to invest in a new type of instrument — Equity Exchange Traded Fund (ETF). The FBM30etf will be the first ETF, introduced by AmInvestment Bank Group, to be listed on the Bursa Malaysia next Monday.
What is an ETF?
An ETF is very similar to open-ended unit trusts. It's an instrument representing a basket of stocks that is most commonly designed to track the performance of all kinds of indices. For example, there could be an ETF to track the KLCI, the Second Board Index; a sector index, like the Property Index; or in this case, the FTSE Bursa Malaysia Large 30 Index. More innovative ETFs can track commodities like oil futures and gold.
Why invest in ETF?
ETFs, like unit trusts, offer investors the benefits of diversification. For instance, an investor buying the FBM30etf will gain exposure to the 30 largest companies by market capitalisation, all in one. In other words, they don't have to fork out a lump sum of money to buy each and every one of the 30 stocks — just the minimal one board lot (or 100 units) of the FBM30etf.
Better yet, ETFs usually has lower expense ratio than comparable unit trusts. Annual management fee for unit trusts usually range between 1% and 2%. By comparison, the annual administrative fees for FBM30etf are estimated to total around 0.65%.
The lower fees and expenses are, primarily, because ETFs are passively managed funds. That means the underlying portfolio of stocks and weightings simply mirror the indices they're tracking. In short, investors do not get the benefit of fund managers stock picking or timing the market. Having said that, it remains arguable whether actively managed funds do perform better over the longer term.
Unit trusts also have higher sales charge, typically 5% or higher, whereas the transaction costs for ETFs are similar to those for normal shares trading including brokerage commission (0.3% to 0.6%), stamp duty and clearing fees.
How to buy and sell ETFs?
Trading in ETFs is also a simpler and more convenient process — it's just like stock trading. Investors can buy or sell the ETF by calling their remisiers at any time during trading hours and using the same trading/CDS accounts. This allows investors to be more responsive to market changes. Transactions are settled in the usual way as stocks are, on T+3.
The price of an ETF is determined by demand and supply but shouldn't stray too far from the market value of its underlying portfolio. ETFs also normally have a dividend policy. The FBM30etf expects to distribute any dividends and interest income it receives semi-annually, after netting expenses.
In a nutshell... ETFs offer investors a relatively low cost, passive way of investing in the market. Returns will more or less mirror the future performance of the underlying index. Under prevailing trading conditions, we suspect that the FBM30etf will do fairly well.
While sentiment for the broader market has been somewhat ambivalent of late, share prices for key blue chips have been inching higher. The FBM30 Index has risen some 47% since its creation just over a year ago, while cumulative gains year-to-date stand at roughly 25%.
This first article of a four-part series by Bursa Malaysia on Exchange Traded Funds provides investors insights into index investing
Have you heard how sometimes people refer to the stock market by asking “where is the market today?” When they use this phrase they are actually referring to an index. A good example of an index that we have all heard about is the Kuala Lumpur Composite Index, more commonly known as the KLCI. If the response is: “the market is up”, this would mean that the KLCI is higher today than the day before. But why is an index important? And how can investors use it to make money?
An index is important because of what it represents. Because it is too difficult to track every single share trading on the stock exchange, we instead create an index that tracks the more “relevant” shares. These relevant shares, normally the heavyweight stocks, are so important that when they appreciate, the entire bourse goes up and when majority of them lose value, the entire stock market is on its way down. An index must define exactly what criteria it uses to select its shares. The beauty of an index is that it is extremely easy to understand and investors know exactly what they are acquiring by putting money in an index.
How an index is constructed
Because an index is made up of a basket of stocks, one must note that it can be constructed to represent any segment of the stock market. For example, one of the more widely known indexes in the world is the S&P 500 Index created by Standard and Poor’s Index Services.
The S&P 500 represents 500 of the most widely held companies in the US such as General Electric, Microsoft and Tupperware. Shares within this index trade on major US bourses such as the New York Stock Exchange and Nasdaq.
Regarded as one of the best indicators to gauge performance of the American equity markets, the job of many American fund managers is to produce returns that outperform this index.
Meanwhile, the FTSE 100 index holds the top 100 largest companies listed on the London Stock Exchange. The index is seen as a barometer of the British economy and is the leading share index in Europe.
When the indexes become more familiar, you will start noticing them in every single market and for every possible industry. Remember that anyone can create an index. During the dot-com bull market almost all the publications in the US created an index to represent different types of new-economy stocks. What sets the big indexes apart is the reputation of the company that creates and manages the index.
Another way to differentiate one index from another is how it measures the importance of each security within its basket. Think about a shopping or a to-do list. There will always be an item that is more important than the rest. This is the same for an index; there will always be shares of companies that are more influential to the entire market due to their size or share price.
A common method used by indexes around the world is to weigh companies based on market capitalisation. For example, say company ABC has a market capitalisation of RM1mil, and the total value of all the companies within an index is RM100mil. This means that shares of company ABC would be worth 1% in this index. These calculations are done up-to-the-minute with computers, making indexes an extremely accurate reflection of its chosen market.
How an investor can make money
An index requires very little maintenance. Other than the occasional fine-tuning, it only needs to hold on to its basket of stocks from year to year. This means lower costs for an investor. When you invest purely in an index, there are no fund managers to pay for their stock picking skills, as there is no active stock picking involved! This means more of your money is invested and gets a chance to grow.
In countries like the US, the expense ratio which translates as the “cost of investing” of an index fund can be as low as 0.15%. Compare this cost with the expense ratios of actively managed funds (funds that have a fund manager and a team of analysts selecting stocks to buy or sell), which can exceed 5%. The difference in cost to your investment is show in Table 1.
With an index, investors get to decide on what and where their money should go. For example, if you believe that China’s economy will continue to grow with each passing year, you could jump on China’s bandwagon by investing in an index that tracks the country’s main stock market.
Index investing is said to be the safest gateway to invest in an unknown market as it (the index) is already diversified – a quality much desired by investors to smoothen out volatility (the losses and gains in the value of your investments).
In most cases, an index would consist of the top leading companies in a stock market. Is it possible to lose all the money that you invested in that index? Yes, but the odds of all leading companies going bust at the same time are slim. Even if it does happen, chances are all actively unit trust funds would be suffering the same fate.
Clearly, index investing will not work for you if your strategy is to make short term gains by “beating the market”. Making money with an index takes the same amount of time required for an economy to grow – years. But your investment is cheap and less risky than the average actively managed fund.
This is not to say that actively managed funds are not good. There are excellent fund managers out there that produce amazingly high returns such as the famed Peter Lynch of Fidelity Investments. Your problem is in identifying them and waiting for them to work their magic.
Also note that to compensate for the higher cost involved in an active fund, fund managers must outperform their respective benchmark index by an average 2% per annum just to match performance of an index fund tracking the same index.
How to invest in an index
There are two ways to go about investing in an index: via an index unit trust fund and an exchange traded fund (also known as ETFs). For the first option, investors must need to be aware that not all index funds are created equal.
Any fund company can create and sell index funds and some companies may charge a healthy sales commission and a high yearly management fee which immediately wipes out the main advantage of index investing – its low cost.
An ETF is a different vehicle that investors can use to invest in an index. The main difference with ETFs versus standard unit trust funds is that it trades like a normal share on the stock market throughout the trading day.
In the more matured financial markets, ETFs are growing increasingly popular with investors. The sale and purchase of ETFs make up approximately 50% of the daily trade volume on the American Stock Exchange (Amex).
In the next article, we will discuss the how ETFs work and their benefits and advantages. Simply put, the more you know about the universe of investing and all the different vehicles available – the better chance of finding the right investment at the cost and risk level you are willing to pay, for your portfolio.
KUALA LUMPUR: AmInvestment Bank group, which will list the country's first equity exchange traded fund (ETF) - the FBM30 ETF - on Bursa Malaysia main board tomorrow, plans to roll out more ETFs, of which some may provide exposure to overseas markets.
Without specifying the time frame for the launch, chief executive officer and executive director Datin Maznah Mahbob said to enhance the growth of ETFs, the group would not limit its investment in local assets but also pursue foreign ones.
“Launching and listing ETFs is part of the group's strategy to offer more innovative products to our investors and also boost the trading liquidity in the equity market,'' she said in an interview.
Director for equity and derivatives Wong Kum Cheong said syariah-compliant ETFs, ETFs giving exposure to overseas markets and those with underlying assets in commodities would be among the probable ETFs expected to be introduced.
Apart from the FBM30 ETF, the group also launched its first ETF in 2005 - the ABF Malaysia Bond Index Fund, a component of the Asian Bond Fund.
Maznah said she foresaw the listing of the FBM30 ETF to spark investors' interest in such instruments and further boost the local capital market.
This was due to the various benefits such instruments provided to investors, she said.
According to Wong, diversification, low cost investment, easy access to information, liquidity and flexibility are among the advantages of investing in such instruments.
The FBM 30 ETF tracks the performance of the top 30 biggest companies listed on Bursa Malaysia. Due to its dual attribute of being a unit trust and being listed and traded on the exchange, the fund could also be used by both medium- to long-term investors for short term trading, said Wong.
Maznah said the fund also suited investors locally and hedge funds as it allowed for easy entry and exit of the market and with lower cost of investment compared with unit trusts.
For unit trusts, she said investors had to pay an upfront fee of between 3% and 5% but the transaction cost for ETFs was similar to that in the stock market.
On the outlook of such funds, Wong said he expected growth in view of the pent-up demand for such instruments in Malaysia.
Compared with more developed markets such as Hong Kong and Singapore, Malaysia was still lagging far behind in terms of such funds. In the more matured financial markets, ETFs are growing in popularity among investors. The sale and purchase of ETFs and its related share transactions made up a significant portion of the daily trade volume on the American Stock Exchange, he added.
This is the second article of a four-part series by Bursa Malaysia on Exchange Traded Funds The worlds’ most heavily traded ETFs.
INVESTORS tend to own far too many stocks. They fail to realise the inherent risk and high investing cost that comes with this approach. Every industry from biotechnology, pharmaceuticals, telecommunications to financial services have alluring companies, all vying for your investment dollar. Your portfolio will eventually resemble the entire stock market if your strategy is to acquire market stalwarts of each sector. Any returns produced by this investing approach are encumbered by numerous transaction costs while a significant amount of time is required for record keeping and monitoring of each company’s progress.
This is when passive investing proponents argue in favour of tracking an index. The objective of this investment approach is to match the total rate of return on an underlying market (or asset class) or any segment of the market, as measured by an index such as the FTSE Bursa Malaysia Large 30 Index.
The main benefits of index investing is its low-cost, maintenance free structure, the broad exposure and diversification it instantly brings your portfolio which can be a stake in the entire market (via the country’s benchmark index) or specific segments or industries – large cap stocks, small cap stocks, bonds, biotech, energy, real estate investment trust and commodities.
There are two vehicles available for investors to invest in an index – an index fund or an exchange-traded fund. Index funds are more familiar in our market as they have been in existences for several years. You buy and sell these funds as you would with any unit trust funds. The key difference with index funds is substantially lower fees because a passive investing strategy does not require fund managers and their stock picking skills. (Take caution: Akin to bond funds, index funds should never cost as much as actively managed fund.)
What are Exchange-Traded Funds?
Now, think of an index fund that can be bought and sold on the stock market. This is the second vehicle known as an exchange traded fund or ETFs in short, which is used by investors to gain exposure to an index.
Exchange traded refers to shares that trade all day long and ‘fund’ describes hundreds or thousands of securities under one umbrella unified by a particular investment objective. In the past five years, this investment vehicle has been attracting billions of investing dollars in foreign markets and marketers continue to launch new ETFs as they find new indexes.
Global ETF assets surged from US$226bil in December 2004 to US$322bil in 2006. Interestingly, some of the world’s most popular ETFs have been trading under cute labels such as cubes, vipers and diamonds. (Refer to box story: The World’s Most Heavily Traded ETFs).
Why the Excitement over ETFs?
ETFs allow investors to focus on something that is extremely important: choice of asset class. There are ETFs that track performance of the entire stock market to various segments of it: large stocks, small stocks, energy, real estates investment trust – virtually any sector or industry of the market. There are ETFs that mirror the bond market (such as the first ETF in this country), even ETFs for commodities such as a recently launched ETF for gold which is backed by actual gold bullions stored in a vault. Pick an asset class that is publicly available for investing and there is a very good chance that it will soon be represented by an ETF.
While this sounds like something index funds can offer, ETF are a better fit for some investors because of its cost structure and flexible nature. Annual management fees can go as low as 0.9% of assets, which is much lower compare to the index fund management fee of 1.5%. The only other significant costs involved are brokerage fees, which is the same amount that you would have to pay to trade ordinary shares. This makes ETFs economical to buy and maintain over the long run, a trait that is especially attractive for the typical buy-and-hold investor.
The flexibility of an ETF comes from its listing on a stock exchange. Investors that acquire or sell an ETF can lock in its price instantaneously during trading hours. Traditional index funds like any other unit trust funds take orders during the day but the actual buy or sell transactions occur at the end of a trading day.
There is a common misconception about ETFs that should be put to rest. Unlike a share, liquidity of an ETF is not dependent on its average trading volume or the number of shares traded each day but more the liquidity of the underlying securities it is invested in. This is because the mechanism behind an ETF is far more complex than unit trust funds. A combination of players from brokers, financial institutions and market specialists work behind the scene as market makers for the ETF. Their role is to create or redeem ETF shares by using shares of the companies in its underlying index. This is beneficial to investors because it ensures a fair price for the ETF which is in line with its underlying net asset value.
Conclusion
The essence of an ETF, as with an index fund, is passive investing which downplays stock picking in favour of buying the market. As an investing tool, there is a lot an ETF can offer. It is easy and cheap to transact and provides instant diversification. In many cases, ETFs address specific market sectors that unit trust funds do not.
This article is written by Noripah Kamso, chief executive of CIMB-Principal Asset Management Bhd
The worlds' most heavily traded ETFs
Nasdaq-100 Index Tracking Stock (QQQQ)
The ETF known as cubes (so named because of its QQQQ ticker symbol) trades on the American stock exchange and tracks the Nasdaq-100 index. This index consists of the 100 largest and most actively traded non financial stocks trading on the Nasdaq market. Because it eradicates the risk of investing in individual companies, QQQQ is used to invest in the long-term prospects of the technology industry. Between 2000 and 2004, QQQQ was by far the most heavily traded index fund.
Standard & Poor’s 500 Index Depository Receipts (SPDRs)
Spiders is the nickname of the first and largest ETF in the world. This ETF offers investors, a cost effective and hassle free approach to investing in the top 500 largest traded companies in the US, as it tracks the S&P500 index. Imagine the expense and effort required to individually acquire all 500 stocks that make up this index.
DIAMONDs Trust
Another ETF with a cute name is DIAMONDs. This popular ETF tracks the Dow Jones Industrial Average, a benchmark of 30 blue chip stocks selected by The Wall Street Journal. This index serves as a good barometer for the very large old-line American companies.
Vanguard Index Participation Receipts (VIPERs)
VIPERs are Vanguard’s brand of ETFs. Vanguard Group is a major mutual fund company with billions of dollars invested in various types of index funds. Their umbrella of products includes ETFs for many different segment of the market such as financials, healthcare or utilities.
This is the third article of a four-part series by Bursa Malaysia on exchange traded funds
Over the last two weeks, we have been reading articles in this column about indexing and investing in indexed funds such as in exchange traded funds (ETFs). ETFs provide a whole new way of investing that offers ease of diversification, lower cost of trading, transparency and access to markets.
ETFs are popular simply because they are so easy to use! You just trade through your remisier or via online trading, that is, the same way you trade shares. It is not necessary to open any new account as you can utilise your existing trading and depository (CDS) accounts maintained at your broker.
ETFs are continuously priced because they are listed on an exchange and you can trade anytime throughout the day, as long as it is within the trading hours at the Bursa Malaysia.
This gives investors the flexibility and price transparency to time the entry and exit of ETF units.
The transaction cost is similar to that of trading shares, which is your normal brokerage charges. In fact, it is lower than that of unit trusts.
The management fees and sales loading of unit trusts are usually 3-5%, whereas ETFs incur lower management fees by virtue of being passively managed.
ETF unit trades settle on T+3 just like shares. If you need to tally up how much ETFs you own, just check your CDS statement.
In addition to the flexibility, transparency, and cost-savings, ETFs are fully diversified with their respective indices.
Hence, investing into ETFs exposes the investors to instant diversification in the index portfolio, thus saving the investors’ efforts in stock picking.
Investors wishing to re-allocate funds to other asset classes are able to do so with little effort and at a low cost since ETFs are traded like stocks. For example, investors can convert cash into a diversified equity portfolio and vice versa, with a single trade of the ETF.
Portfolio managers seeking to track benchmarks often need an efficient way to quickly invest excess cash, preferably in an instrument that has a high correlation to their benchmark. Index ETFs provide a clear preferential choice, given the variety of sector, style and industry categories available.
While the ETF’s ability to trade liquidly in the market is a top concern in every investor’s mind, the existence of the participating dealers (financial/brokerage firms) provides continuous liquidity for investors to trade the ETF units.
In fact, ETFs gained popularity because of the innovative features and ability to provide excellent liquidity. Investors enjoy the freedom of trading on an intraday-basis as well as placing market, limit and stop-loss orders for the ETF units.
Last week, Malaysia’s first equity ETF was listed by the AmInvestment Bank Group. The FBM30etf is like a unit trust that invests in a portfolio of exactly the 30 stocks that make up the FBM Large 30 Index.
The FBM Large 30 Index was in turn, designed by Bursa Malaysia in collaboration with UK’s FTSE to serve as the new barometer for the broad Malaysian equity market.
Incidentally, the FBM Large 30 Index tracks the older KLCI quite closely and that’s not surprising since more than 73% of the KLCI is actually in the FBM Large 30 Index.
The FBM Large 30 Index is, however, much more liquid and hence, much easier to replicate (in our business, replicating an index simply means buying a portfolio of exactly the same stocks that are in the index in exactly the same proportion).
So, whether you are a long-term investor or a short-term trader, the ETF units can be used to carry out your investment or trading strategy. They are cost effective and are especially useful in situations where you have no specific view or preference for a particular stock.
Due to the diversity of its holdings, ETFs are ideal for investors like you who lack the time or inclination to select individual stocks.
Now that you heard of the ETF and its versatility, the next time you want to invest or trade in the local equity market, call your remisier and ask about how you can maximise trading opportunities with ETFs.
This article is written by AmInvestment Bank Group
As the number of ETFs in Malaysia is expected to rise soon, let’s discuss why and how to pick an ETF and how to use ETFs in an investment portfolio.
ETF advantages
Exposure to broad markets
From a strategic standpoint, ETFs can be quickly and easily used to assemble a broadly diversified index portfolio invested in major market sectors. Say, you are confident of India and China's growth prowess but are unwilling to take a bet on a specific share.
If there are ETFs that track each country’s benchmark index, they can provide that exposure along with instant diversification (because it holds a basket of securities that mirrors the benchmark index).
It is very unlikely that all companies will collapse at the same time. Then, execute the simple buy-hold strategy to ride on further development from these economic giants. It would be far more complicated to invest in individual stocks.
Low-cost investing
Perhaps the biggest advantage ETFs have over its index fund counterparts is their rock-bottom cost.
There are low fund manager’s fees to pay, giving most of your invested capital a chance to grow. The annual operating cost of an ETF is meagre, ranging around 0.12%.
Index funds, another passive investing vehicle that tracks an index, should also be cheaper than actively managed funds (those with a dedicated team of stock pickers).
If the ETF tracks less popular and widely-accepted stock themes, its annual expense ratio may inch closer to 1%, which is still substantially lower than the charges imposed by index funds in this country.
There is one caveat to remember: ETFs trade on an exchange, so you will need to pay brokerage commissions to buy and sell them, just as you would with stocks. The trading cost will pile up if your strategy is to trade in and out of the ETF frequently.
Flexibility
There is, however, an advantage to trading ETFs on the stock market. Acquisition and disposal is done during trading hours and investors can lock in a price for the ETF immediately.
If your ETF tracks a volatile market that suddenly starts tumbling, you can dispose of your investment during market hours, before the price of the ETF drops any further.
In a traditional fund, your sell order is transacted based on the fund’s net asset value at the end of the day, regardless of when you put in your order to sell.
Time efficiency
Many investors do not have the time to monitor the progress of individual stocks or to study the company’s annual reports.
Due to the diversity of its holdings, ETFs are ideal for investors who lack the time or inclination to select individual stocks.
ETF disadvantages
Market risk
This is the same risk you face with stocks and unit trust funds. An ETF is not exempted from market risk and volatility as it replicates the performance of an index by investing in the same basket of securities and in the same proportions.
If the index performs well, the ETF is likely to do the same. If the index does poorly, the ETF's performance will be similarly affected.
Too much flexibility? Once you know exactly what the ETF is going to bring to your portfolio, stay away from excessive trading.
The ability to move in and out of ETFs quickly can lead to the temptation of jumping into markets or industries that you see poised for growth and bailing out when performance tumbles.
This is a great strategy in theory; but in reality, it is extremely difficult to execute. Investors tend to make the common mistake of buying into a ‘hot’ sector after prices have been pushed up, only to sell at a loss when prices start correcting.
From a cost perspective, frequent trading could eventually lead to the brokerage commission exceeding the fees imposed by index unit trust funds.
For these reasons, it would be wise to think like a long-term investor and view the ease and flexibility of trading ETFs as a just-in-case feature, only to be used when the market springs an unexpected and unpleasant surprise.
How to pick an ETF
In principle, an ETF is not any more complicated than its underlying securities. If you know enough about what it holds, you know enough to invest in an ETF.
To avoid the most common foibles, all you need is a little due diligence on its investments and exercise some trading restraint. If you believe its unique design and flexible nature can be leveraged on, here are some tips on how to pick an ETF.
Any time you are faced with a new product or a new asset class, go back to the asset allocation of your portfolio.
To be successful, investors must know the percentage each asset class should occupy. The importance of asset allocation cannot be overstated.
Many investors spend too much time and too much money picking individual stocks instead of evaluating what type of stock or fixed income instrument they should be holding.
After you have identified the key areas of exposure in your portfolio, such as a specific market, industry or stock type, then identify ETFs available to you.
Read up on the investment objective of each ETF and obtain its top 10 holdings or sector distribution to ensure it is invested in the industry or assets that you want.
ETFs must file annual or semi-annual reports on its investments. Refer to these reports and its prospectus during your research.
There may come a time when you find competing ETFs invested in similar securities. If this is the case, select the ETF with a lower expenses ratio as listed in its reports.
Once you have found an ETF that fits your overall portfolio there are numerous ways to maximise their advantages.
How to use ETFs in your portfolio
1. Gain exposure to the broad market
This is the most effective way of maximising an ETF.
By buying and holding an ETF that tracks the entire stock market, you immediately gain a diversified portfolio holding all the important stocks in the country.
You can apply the same concept for bonds and foreign investments. For example, the CIMB FTSE Asean 40 ETF listed on the Singapore Exchange tracks the FTSE/Asean 40 Index, which comprises the 40 largest listed companies across Malaysia, Singapore, Indonesia, Thailand and the Philippines, ranked by market capitalisation and free-float adjusted.
2. Filling up the gaps in your portfolio
You may already have investments that give you exposure to certain asset classes in your portfolio.
You can buy an ETF tracking the asset class that you desire, at lower cost and much less risk than buying a stock or an actively managed unit trust fund.
3. Going for specialisation
Want that extra special ingredient in your portfolio? There are more and more specialised ETFs rolling out all over the world. Earlier we talked about a gold ETF but there are many more.
Want property? Look for a real estate investment trust (REIT) ETF. Anticipate a booming healthcare industry? Acquire an ETF which holds pharmaceutical and health-related companies.
4. Stop-loss order
You transact your ETF through a broker or a remisier. This has the fringe benefit of setting a stop-loss order with the person you acquired the ETF from.
After specifying the price at which to sell, you can leave your ETF to track its index without having to monitor its day-to-day price movements.
Parting words
There is much to like about ETFs. As passive investments, they harness the power of the broad market without the risk of single-stock exposure. Granted, they will never outperform the market because their objective is to replicate its performance, less the ETF’s minimal expenses.
As an investment vehicle, ETFs are cheap and can be bought or sold at any time during market trading hours.
When ETFs start proliferating in our market, consider using them to cut back on fees that keep eating away at your capital and to fill up gaps in your portfolio – a simple and effective strategy that works for both the novice or near-expert investor.
This article is written by Noripah Kamso, chief executive of CIMB-Principal Asset Management Bhd
