Let’s take a looking at an excellent investment solution, the Exchange Traded Fund (ETF), and specifically the products provided in South Africa by Satrix Managers (Pty) Ltd.
What are ETFs?
An ETF is an investment fund traded on a stock exchange. ETFs hold assets such as stocks, commodities or bonds and trade close to the net asset value (NAV) over the course of the day. ETFs are similar to unit trusts in the sense that one invests in a “basket” of shares (i.e. a group of shares from a given index or field such as resources, financial or the Top 40) on the stock exchange.
The difference, however is that a unit trust only trades once a day whereas an ETF trades on an on-going basis. Similarly, like ordinary shares, the prices are available to you throughout the day. Most ETFs track an index (for example Satrix 40 tracks the FTSE/JSE Top 40 Index).
A brief history
The first ETF, the TIP (Toronto 35 Index Participation Fund) tracking the TSX 35 Index listed on the Toronto Stock Exchange in 1990. The ETF industry grew rapidly in Canada and by the end of April 2011 the Canadian ETF Industry had 180 ETFs, 211 exchange listings and assets of US$43.1Bn from four providers on one stock exchange.
Over this period ETFs expanded internationally in the United States, Europe, Asia, Australasia and other parts of the world. At the start of 2010 the ETF industry had grown to just over US$1 trillion and by the beginning of March 2011 exchange traded products had grown to US$1.5 trillion.
In South Africa, Satrix started in 2000 with the launch of the first ETF, the Satrix 40. Satrix 40 endeavours to replicate the performance of the FTSE/JSE Top 40 index. This index constitutes the forty largest companies, by market capitalisation, listed on the JSE.
In August 2004, Satrix registered with the Financial Services Board as a Collective Investment Scheme. This means that all Satrix securities are treated like unit trusts in terms of taxation, compliance, investment exposures and reporting. The fact that Satrix is both a Collective Investment Scheme as well as a publicly listed securities trader means that it adheres to the regulations and legislation of both the Financial Services Board as well as the JSE.
How can one trade ETFs?
There are two ways in which you can buy and sell ETFs, either through the primary or secondary market.
The primary market is where the investor purchases the securities directly from the issuer. If you invest in the primary market directly with Satrix Managers one has to invest in a basket of securities equal to 1 million units of the respective Satrix fund.
In the secondary market the investor purchases the securities from other investors as one would do with any other ordinary share trading on a stock exchange, rather than directly from the issuer as with the primary market. Exchanges such as the Johannesburg Stock Exchange are secondary markets.
Investors that invest in the secondary market will do so by investing through a broker or other platforms such as the Satrix Investment Plan.
When an ETF is created, it is pegged to a benchmark. For example in the case of the Satrix 40, the benchmark is the FTSE/JSE Top 40 Index. Stocks are held in the same proportion to the market index so therefore if the index or sector does well so does the ETF. If the index drops, so will the ETF. In other words, the ETF tracks the index to which it is linked.
Advantages and risks of ETFs
ETFs combine the advantages of investing in index funds, including diversification and low costs, coupled with the liquidity and flexibility of investing in individual stocks. ETFs offer investors many advantages over other investment vehicles, including diversification, liquidity, cost effectiveness and transparency.
As with any investment opportunity that trades on a securities exchange, the return received is subject to fluctuations associated with market conditions. Although ETFs are considered to be a lower risk investment solution over medium to long-term investing, the stock exchange can be risky.
Therefore depending on the market movement one is not guaranteed to get back the initial amount invested when you do decide to sell. Fund performance may be affected by changes in economic and market conditions, political developments, changes in government policies or changes in legal, exchange control, regulatory and tax requirements.
Furthermore the tax implications will vary depending on the tax status of the investor in question. Therefore, investors should seek their own professional tax advice and consult with a knowledgable financial advisor for all decisions related to financial planning and investment opportunities.
Blackrock ETF Landscape June 2011