Oh no they’re not!

Oh no they’re not!

I attended the launch presentation of ETFSA towards the end of November. Exchange traded funds are increasing in popularity both globally as well as locally so I thought I had better find out more. ETFSA is an investment platform which provides access to all the ETF’s in SA and also plans to make a an ETF retirement annuity an option.

While I can see the role that ETF’s can play in an investor’s portfolio there are a few misquoted stats and bits of information doing the rounds. Let’s look at a few of these…

1.       According to Mike Brown and the slides he put up, “ETFs typically provide beta returns and low risk”. Oh no they don’t! I understand what he was trying to say but I am not sure that the bulk of the audience did. EFTs have a low tracking error and so there is a low risk of them not matching their benchmark, but they are not low risk investments. Just like unit trusts, and ETF is an investment vehicle, it depends how it is invested! An ETF that invests only in shares cannot be low risk – especially if we use volatility as the traditional measure of risk. So anyone wanting to buy into ETFs needs to understand the relevant benchmark that the fund tracks and the associated risks.

2.       According to the presentation slides, ETFs are cheap and unit trusts (largely because of their performance fees) are expensive. Yes, some unit trusts are expensive because of the performance fees…but that is exactly the point – they have performed and therefore there is a performance fee! I agree, not all performance fees are equal and some of them are not calculated against appropriate benchmarks and worse still, some do not take into account the fact that new investors will never benefit from the past performance and so should not pay performance fees on past performance (but that is a topic for another post). But to put up a slide that shows that you could pay 11.5% per annum for a unit trust is, at best, misleading.

3.       According to the slides, ETF’s outperform unit trusts. Let’s look at the Coronation Top 20 fund which “aims to outperform the FTSE/JSE Top 40 Index, is actively managed and typically holds no more than 20 large cap stocks at any point in time”. The fund has a performance fee on it and the TER (total expense ratio) is 3.28% pa, of which 2.13% pa is the performance fee. How has the fund performed? Since inception it has beaten the benchmark (effectively the SATRIX 40 Fund) by over 7% per annum. I will happily pay a performance fee for that thank you! It is true that there are a great many “average” fund managers out there and that many of them don’t beat the index. In SA, however, we have some very good managers who consistently and repeatedly beat the ALSI – partly because they are good at what they do and partly because the ALSI is so heavily skewed towards resource shares. So invest in an ETF by all means, but just because you do (and because it is cheaper) does not mean you will do better than if you had invested in a comparative unit trust fund.

4.       Lastly, ETF’s definitely have a place in a portfolio but if I was going to invest into an ETF I think I would go direct and not via a platform – you are just adding another layer of fees (which was one of the criticisms about unit trusts). I think the only time I would probably use a platform is if I wanted to invest into an RA – now that might make sense.