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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.
