The passive aggressive investor
Exchange-Traded funds (ETFs) have been around for about 20 years, and are becoming increasingly popular not just with individuals, but with institutional and retirement funds too. In a nutshell, an ETF will passively ‘track’ and index by buying and selling shares in the same ratios that are found in that Index on the stock exchange (South African ETFs, some offshore ETFs do not physically have to hold those shares). The ETFs are quoted on the exchange and move in price during the day, just like a stock. These indices are ‘groups’ of shares, for example the AllShare index (all the shares on the JSE) or the Resource index (the resource funds). More and more ETFs, using increasingly specialised indices, are being added all the time.
The allure of an ETF is that it gives you the same return as that index, without having to buy the underlying shares (which would be prohibitively expensive). While there are collective investments that might mimic the index, the ‘active’ manager will usually change the allocations to try and beat the ‘average’ – and justify his fee. ETFs are passive. There isn’t an asset manager fiddling with the allocation. Its role is to be average. Because these are true ‘trackers’ and the asset manager doesn’t have to think, just follow, the costs are significantly reduced – and that is where the benefit is. Ironically, because the costs are so much lower than Collective investments, this ’average’ is usually way above ‘average’ for the sector in real terms.
In some respects the asset managers in the South African market are lucky because the (usually) double digit growth makes the odd one or two percent they charge less noticeable than their American or European counterparts where single digit growth is more common. If you’ve only made 5% in a good year, you’re not going to be impressed with a 2-3% fee being taken off it! These fee concerns have resulted in the massive popularity of ETFs offshore, and my recommendation to anyone investing offshore is that they use ETFs and not funds. Interestingly Discovery’s Dollar fund investments (which like the life cover will pay offshore, and uses the R1m annual allowance to pay for the premiums) uses ETFs for the investment portion.
Until fairly recently, financial advisors haven’t given advice on ETFs because they cannot earn commission on the investment. Fee-based advisors of course had no such issues, but Independent Financial Advisors can now be accredited on some of the ETF platforms and get remunerated for the advice. In addition to this, some of the ETFs have been converted to Collective investments and are available on the major LISP platforms. The difference between the ETF and Collective Investment ETF is that ETFs trade in real-time all day, whereas the Collective Investment is only quoted once a day (and have some protection because funds have to be held in trust with a third party institution). By ‘unitising’ the ETFs you can now get other asset classes mixed in with the passive, equity core to get ‘balanced’ funds that are required in retirement funds, and investors looking for less ‘risk’. This change in remuneration is a win-win. The client gets the best advice, and lowest fees, and the financial planner is remunerated for the advice without having to change their business model to fee-only (which, in South Africa certainly, only really suits the high net worth and sophisticated investor).
So, when does passive investing make sense? Because of the pure-equity nature of most ETFs, the investment is considered ‘aggressive’ and should be used for long term investments and surplus funds once the retirement goals have been reached (it can and does happen). If you don’t want to buy an off-the-shelf managed fund, your advisor can use an ETF/Collective investment ETF as the ‘passive core’ and add other asset classes like bonds, cash or property to ‘balance’ the fund. SATRIX has also introduced Tax-free savings account (TESA – see HERE for more) alternatives. TESAs have been designed to be long term -there is a lifetime R500,000 cap, and any amount withdrawn cannot be replaced. If it’s going to be there in the long term, it might as well be aggressively yet passively invested. Low cost and tax-free? Sounds like a good idea.
Actions: As part of your investment analysis, make sure the fees are looked at, and understand their impact on your portfolio over time. Consider swapping out expensive funds with cheaper ETF Collective investments, especially for long term investments.
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Author Dawn Ridler