Newbies and more experienced investors are increasingly realising the value of using exchange-traded funds (ETFs).
You don’t have the anxiety of which shares to choose, as ETFs allow you to "buy the market" at affordable investment amounts.
This is possible through an increasing range of ETFs — and unlisted index-tracking unit trusts — that track indices of shares across local or global markets, known in the industry as "broad-based" indices.
If you are an ETF investor, you will also see a growing number of funds focused more narrowly on sectors, countries or investment themes. Long-term investors can use them to add to their broad exposure a smaller sector or theme tilt, but doing so sensibly means understanding what you hold.
For your primary focus on getting the broad exposure to the markets, the following are your options.
LOCAL MARKET ETFS
1. The FTSE/JSE top 40 index
There are four ETFs that track this index of the 40 largest shares on the JSE, and the most popular one is the country’s oldest ETF: the Satrix 40.
Simple to understand and with a solid average annual return of 13.8% a year for more than 20 years since its launch, it was voted The People’s Choice in the recent SA Listed Tracker Awards.
Investors tracking the top 40 index have done particularly well over the past seven years, as the large dual-listed and resources shares that dominate the index have out-performed many shares whose fortunes are tied more closely to SA’s ailing local economy.
But a longer focus shows that the large shares do not always outperform more domestically focused stocks on the JSE, and despite continuing pessimism about the local economy, you may want to consider casting your investment net wider.
Victoria Reuvers, MD of Morningstar’s discretionary investment manager, says while the top 40 may have been a good investment, it is not a well-diversified one. As at the end of March, five shares made up more than 50% of the index and the top 10 shares made up 69%, according to investment management firm FTSE Russell.
2. The FTSE/JSE top 40 Swix index
There are three ETFs that track the top 40 shareholder weighted index, which down weights the large dual-listed shares by excluding what is held on other exchanges. The net effect of that is an increase in the weighting of homegrown heavyweight Naspers.
According to FTSE Russell the Swix top 40 had 24% in Naspers and also 69% in the top 10 holdings at the end of March.
Nerina Visser, strategist and adviser at ETF investment platform ETFSA, says you need to ask yourself if you are comfortable with a single share making up between 20% and 24% of your investment.
Remember, too, if you are invested with any active managers you may have a high exposure to Naspers, because many of their funds are benchmarked to the Swix or the capped Swix, which limits the weighting of any large shares at 10% of the index.
Over longer periods of 10 and 15 years, the returns earned by the FTSE/JSE Alsi and the FTSE/JSE top 40 and their Swix alternatives are relatively small, but the differences are more marked over periods of seven years or less.
Visser says over the long term it won’t make that much difference which of the indices you choose — the main thing is to pick one that gives you broad exposure to the market.
It is much better to get investing than to go into analysis paralysis, she says.
3. The S&P SA Top 50
The S&P SA top 50 index gives you exposure to the top 40 plus 10 mid-cap shares. In addition, the maximum weighting of any of the shares in the top 50 is capped at 10%.
Visser says this is the most diversified broad-based index tracked by an ETF, and it is both her and Reuvers’s choice of broad-based local indices.
Risk-adjusted returns show the top 50 is less volatile, but the top 40 may give you better returns at times on straight performance, Visser says.
Nedgroup Investment head of core investments Jannie Leach says diversification is the key way to manage risks when you invest passively in index trackers, so it is important to get exposure to as big a universe as you can.
Locally, you should get exposure to at least the top 60-100 shares, he says.
Leach says capped indices are now preferred because they reduce the risk of exposure to Naspers, but there are no ETFs tracking the capped indices. The risk can, however, be managed with more offshore exposure, he says.
TILTS ON YOUR LOCAL BROAD EXPOSURE
If you invest in a top 40 or top 40 Swix, you can diversify further into the local market by adding the mid-cap ETF from Ashburton. This will broaden your exposure to 100 shares.
Visser says six months ago would have been a good time to buy into that ETF, but getting in now may still give you some of those indices’ recovery.
But Satrix chief investment officer Kingsley Williams says it is difficult for investors to manage combining funds tracking the top 40 and the mid-cap index and it is a gap in the ETF market.
Beyond this, Visser says you would benefit from more income in your portfolio if you could supplement a broad-based local market ETF with one tracking an index focused on shares that pay good and growing dividends, such as the S&P dividends aristocrats or the FTSE/JSE dividend plus index.
There are now a number of ETFs that give you exposure to investment "factors" with a view to outperforming the broader market. These factors mimic investment styles such as value, momentum or quality.
But Visser says adding factor ETFs can be a minefield. If you don’t know what you are doing you could buy into a style ETF for the wrong reasons. Particularly if you do so after a period of good performance, you may experience poorer performance, which often follows the good in an investment cycle.
BROAD-BASED FOREIGN MARKET EXPOSURE
When it comes to broad-based exposure to global markets, local ETF investors can now choose between ETFs tracking the S&P500, the MSCI world, the MSCI all countries world or an index made up of seven regional or country-specific indices.
1. The S&P 500
Four different ETF providers offer you exposure to the 500 largest companies listed on US stock exchanges. The companies represent about 80% of the market capitalisation in the US and about 50% of global markets.
Though these businesses are all listed in the US, many of them are multinationals that derive their profits from markets around the world.
2. The MSCI world
Three providers track the MSCI world, which is made up of the shares of more than 1,600 companies from 23 developed markets.
US companies dominate the index with a combined weighting of 66%; Japanese companies represent 7%, UK ones just over 4% and companies listed in France and Canada just over 3% each, for example.
Visser says if you prefer to invest where there is momentum in the market, you may take the view that as the US market has performed strongly for the past 10 years, it is likely to continue to do so, and you may prefer the S&P500.
Visser prefers a contrarian view — that because the US market has performed well, the valuations of these shares (prices relative to earnings) are high and they could fall from their current highs. She therefore prefers to track the broader MSCI world.
Neither the MSCI world nor the S&P500 gives you access to emerging markets. Investors in unit trust index funds can track the MSCI all countries world index (ACWI).
This index includes close to 3,000 shares in 23 developed countries and 27 emerging markets. It tracks the MSCI world quite closely but gives you, for example, 5% exposure to China.
By including emerging markets, this index effectively down weights US companies further to about 58% because it includes a 15% weighting to emerging markets, Reuvers says.
Though you can’t track the MSCI ACWI with a single ETF, you can replicate this exposure using an MSCI world ETF together with one tracking the MSCI emerging markets.
At present only Satrix has such an ETF, but Sygnia has announced plans to launch an emerging market ETF this year.
Visser says if you do not have enough to invest in two separate ETFs, it may be better to opt for an ETF that includes emerging market exposure like one that tracks the S&P global 1200. She is of the view that global indices with emerging market exposure underrepresent the economic opportunity emerging markets can offer, and prefers to supplement it with the emerging market ETF.
Williams, however, says it’s best to stick to the allocation to developed markets (89%) and emerging markets (11%) that is in the MSCI ACWI.
He says that over the longer term emerging markets should outperform, but there are heightened shorter-term risks of events like government debt defaults and coups in these countries.
3. The S&P 1200
Ashburton offers a global ETF that gives you access to 1,200 shares the 30 countries represented in the S&P 1200 and capturing 70% of the world market capitalisation. There is a 5.8% allocation to emerging markets.
The ETF gets this exposure through seven underlying ETFs tracking European, Japanese, Canadian, Australian, Asian and Latin American indices.
So far the Ashburton Global 1200 ETF is lagging the S&P500 and the MSCI world over a three-year period, but the broader exposure hedges your bets for the long term with less emphasis on which region will do better than another.
Williams says a broad-based developed market index is a great diversifier away from SA but comes with potentially lower growth rates given that interest rates are low in developed markets.
If global markets wobble and investors flee to "safer" investments, developed equity markets may fall, but you will be cushioned as the rand will weakens in tandem, he says.
4. Global ESG indices
New to market are two Satrix and one Sygnia ETF with an environmental, social and governance (ESG) focus.
The Satrix ETFs track the MSCI world ESG enhanced focus index (developed markets only) and the MSCI emerging market ESG enhanced focus index.
Sygnia’s ETF tracks the S&P global 1200 ESG index.
Williams says if you are concerned about climate issues and other social and governance risks, the Satrix ESG ETFs can be used in place of other broad-based global market ETFs. He says the ESG indices Satrix tracks have a low tracking error from the parent MSCI indices from which they are derived and so you should not expect better returns from these ESG indices.
Only about 200 of the more than 1,580 companies are screened out for practices such as controversial weapons, high thermal coal production, fracking, human rights violations and any other severe controversies such as data privacy breaches. Then companies with poor ESG scores are downweighted, and the outcome is that the holdings have a 30% lower carbon emission than those in the parent index.
The MSCI enhanced focus ESG indices differ from the MSCI’s ESG leaders indices which include only those shares that score best on ESG metrics.
There is an argument that an ESG focus mitigates against longer-term risks as the companies included are those likely to be able to weather unforeseen shocks better, but Williams says this longer-term outcome still needs to be proven.
Indices with an ESG focus may also benefit from a big investor move to ESG-and green economy-focused shares.
Visser is more confident that ESG investing will also bring better returns — she says ESG indices are showing an outperformance of their parent indices of an average of 1%-2% a year over the longer term.
Leach says while investors are right to think about sustainability and responsible investing, an ESG focus means collecting the data and practising active stewardship — voting on company resolutions and engaging with company management to support ESG goals — which adds to the cost.
TILTS ON YOUR BROAD-BASED GLOBAL EXPOSURE
Investors can also get access to ETFs that track equity market indices in a particular region, such as Europe, or a single country, such as the US, China or Japan. Later this year Satrix will add India to this list.
Williams says Satrix’s country-specific ETFs aim to capture the megatrend of economic power shifting east, to China and India specifically. He suggests you use them only as a small subset of an overall portfolio that has broad-based exposure to the global market.
If you are exposed to global and emerging markets in line with the MSCI ACWI proportions, you already have a 5% exposure to China and should take care how you increase that, given the policies and a lack of legal certainty in China.
The beauty of ETFs is that they allow investors to tactically allocate — but you need to know what you are doing and be aware of the risks involved, he says.
Visser says if you have an ETF tracking the MSCI world or S&P500 you already have a big bias towards the US and there is no point adding an ETF tracking the MSCI US. She says doing so is "diworsification" rather than diversification
Leach is not in favour of using any country-specific or themed ETFs. He favours diversifying through a broad-based index, and describes trying to time your exit or entry into less diversified ETFs as "a fool’s errand".
Reuvers also warns against "late-in-the-cycle fad ETFs", particularly in technology.
But Visser sees value in tilting to investment themes or trends such as technology and health care where providers are expected to launch ETFs this year. She says you need to distinguish what is a fad from what is an enduring trend.
There may be some fad investments in technology, but it is also a trend that has changed the way we work, play and spend and is unlikely to disappear soon, she says.
Visser believes ETFs like fourth industrial revolution of Sygnia focus on longer-term trends, but others that track indices that carve out sectors of the broader-based indices have less value.
Single stock exchange traded notes (ETNs) are also now an option, and many are tech favourites, like Facebook, Amazon, Apple, Netflix and Google. But Visser says these ETNs make sense only if you have strong convictions about duplicating the exposure you already enjoy from a broad market ETF.
Commodity ETFs are another tilt, but Visser suggests a small constant exposure of about 5% rather than trying to time your investment in them. Timing commodities is risky, but being exposed over the long term mitigates risk as commodities have a low correlation to other markets, she says.
*As IM was going to print, CoreShares announced it will list a new ETF on the JSE in May which will track the FTSE Global All Cap Index. This index will give exposure to more than 9,000 large, mid and small-cap stocks across 25 developed and 24 emerging markets.
CoreShares MD Gareth Stobie says the ETF will feed into Vanguard’s Total World Stock ETF providing the most comprehensive "all in" global strategy listed on the JSE.
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