EXCHANGE TRADED FUNDS – THE TOOL THAT MAKES THE STOCK EXCHANGE ACCESSIBLE TO THE EVERYDAY INVESTOR

By Mike Brown.

Mike Brown is an authorised Financial Services Provider. He is also a registered (non-practising) stockbroker and has over 35 years experience in South African financial markets and is one of the acknowledged experts on ETFs in South Africa.For more information about etfSA please visit or contact Mike Brown on 011 561 6653

Many South Africans believe that the Johannesburg Stock Exchange is only for those in a certain wealth bracket or those who enjoy the risk and reward of picking stocks. However, this perception is set to change as Exchange Traded Funds (ETFs) become the investment du jour for the man in the street. The Financial Planner spoke to Mike Brown, (MB) the MD of newly launched ETFSA to discuss the success that the global ETF market has experienced and the relevance of these investment products to the local investor.

FP: Please give us some indication of just how successful ETFs have been internationally?

MB: ETFs were first introduced in 1993 and have since enjoyed phenomenal success. In 2009, there were 1,635 ETFs worldwide, with 87 ETF providers on 43 exchanges around the world. According to Deutsche Bank, the total global ETF market is projected to increase its assets under management (AuM) to between $1, 2-trillion and $1, 4-trillion this year. Over the last decade, global ETF assets had a compound annual growth rate of 56.3%. Internationally ETFs have been welcomed by both large financial institutions and private investors.

FP: Mr. Brown, please explain what are ETFs? And how do they work?

MB:ETFs are similar tounit trusts in that both instruments bundle together shares in order to offer investors diversified portfolios. Most ETFs passively track a particular index, such as the FTSE/JSE Top 40 and therefore have loweroperating expenses than actively invested unit trusts. The indices, on which most ETFs track, are regularly rebalanced by the JSE to ensure that they reflect the most successful shares on the exchange. ETFs are attractive as investments because of their low costs (Total Expense Ratio or TER) and the ability to purchase them like a normal exchange listed security. An ETF combines the diversified portfolio of a unit trust investment with the tradability features of a listed security, allowing it to be bought or sold at the end of each trading day at the market ruling price.

FP: Why should an investor invest in ETFs?

MB: In the South African market, interest in ETFs is growing for a number of reasons. Firstly, as these products are passive investments, they have much lower cost structures. Secondly, investing in a portfolio of shares through an ETF rather than purchasing a single share spreads investment risk for the investor. Thirdly, as ETFs are listed on the JSE, an investor can track performance and trade the ETF at any time during trading hours. In addition, ETF owners are eligible to receive quarterly dividends when those shares within the basket of shares pay dividends. In terms of investor protection, most ETFs are classified as a registered Collective Investment Scheme and are regulated by both the JSE and the FSB.

FP: Who should invest in ETFs? What will grow the ETF market in South Africa?

MB: ETFs are well suited to the everyday investor as well as large institutional investors. Institutional investors can gain broader market or sector exposure where gathering fundamental research is difficult. ETFs are a fantastic way for the average South African to begin investing on the JSE – a portfolio of shares is less volatile and carries less risk than investment in a single share. Investing in ETFs is also affordable; investors can purchase ETFs through investor platforms such as the etfSA Investor Scheme from a lump sum minimum of R1000 or via a monthly debit order for about R300.

Key to growing the ETF market in South Africa is education – both basic financial education and also education specific to ETFs. Many South Africans have the misperception that investing on the stock exchange is for the elite or those with a large risk appetite – this is not the case. We believe that financial planners can play a vital role in overcoming this hurdle by informing and educating their clients about ETFs as a low risk, low cost and safe way to trade on the JSE.

FP: Tell us a bit about etfSA?

MB:etfSA is a FSB registered South African operation that allows investors to buy, sell, transfer and switch any one of the 223 ETFs available in South Africa - whether these are offered by Satrix, Deutsche Bank, Absa Capital or others. In essence, this makes us a one stop shop for ETFs. We make use of an administration (LISP) platform called itransact™, which is owned and operated by Automated Outsourcing Services (Pty) Ltd, an authorised financial service provider administrator of Exchange Traded Fund products.etfSA also provides a wide range of ETF related information, including a price ticker for all the ETFs, performance information, new products, fact sheets about the products and current ETF news. We perform a quarterly performance and cost survey of all ETFs and ensure that all ETFs purchased are registered in the individual investors name on the Strate register.

FP: Tell us about the commission structure that ETFSA offer financial planners?

MB: The growth of the ETF market in South Africa has been hampered by the fact that registered intermediaries and financial advisors have not received a commission for the ETF products that they invest in on behalf of their clients. etfSA changes this by registering FSPs and paying trailing commissions (up to a maximum of 1% per annum) to financial advisors – similar to the commissions they would receive for a unit trust investment. The client has to agree to the payment of such commission on the application form and etfSA will then calculate and pay over commissions to the FSP on a regular basis. The annual administration fees charged by etfSA to the client are exactly the same as those paid for other transaction platforms, such as the Satrix Investment Plan, etc., but etfSA offers the financial intermediary and the investor a far wider choice of product, with no penalty in terms of higher costs.

FP: Any final thoughts?

MB: Suze Orman, personal finance author calls ETFs the unit trusts for the 21st century. In a nutshell, ETFs are a great tool to create a diversified investment portfolio that allows investors to have more minute-by-minute control of their investment at a lot lower cost.