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PR Newswire
04-01-2011, 11:02 AM
Reproduced below from Share Investment
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A Portfolio of ETFs
by Andy Chiok
According to Barclays Global Investor, the United States is the world leader in Exchange Traded Funds (ETFs) with assets under management of US$640 billion while Europe comes in at a distant second with US$206 billion of assets. Globally, ETFs stand very close to the US$1 trillion mark, with US$942 billion in assets at the end of October 2009. There are 1,859 ETFs listed in 40 exchanges around the world.
In Singapore, ETFs have been listed on the Singapore Exchange since 2002. In 2009, the Singapore ETF market has hit over S$800 million in turnover and 120 million in volume. As of January 2010, there are 49 ETFs listed covering equities, commodities, fixed income, and money market.
So, why are the majority of investors in Singapore still engaged in stock picking? Why is the financial planning industry here still holding on to unit trusts and not offering clients the benefits of relatively low cost, convenient, transparent, and well-diversified tracker funds that are traded on stock exchanges around the world? When asked if he will be starting ETF investing, a top executive who has been tasked to restructure a local wealth management firm says, “…for now, we will only be looking at unit trusts. Maybe we will be starting ETF trading in the future. But not now.â€
New Independent, a financial planning/ advisory firm in Singapore, has launched ‘wrap accounts’ for ETFs with a product called Fulcrum in 2009. According to Joseph Chong, Chief Executive of New Independent, “Fulcrum (will) allow the investor to go long or short in equities, fixed income, commodities, etc. (It will) allow the individual investor to invest like a hedge fund but with transparency, control, and low cost.â€
Despite all the advantages, the take-up rate is not high. This leaves one to suspect that the bulk of the figure being released by the Singapore Exchange on ETF trading relates to institutional investors. Ignorance on the part of investors and financial advisors (they are insurance agents, after all) and the preference for the familiar may be reasons why ETF is ‘shunned’. There is even a ridiculous boast on an online investment forum of the ability to trade the stock market by observing movements in ETFs!
Which brings us to the question, “What is an Exchange Traded Fund?â€
An ETF is traded over the stock exchange and is bought and sold just like ordinary stocks and shares. It tries to replicate a particular index so buying an ETF is tantamount to buying the entire basket of stocks that are composites of the index. The biggest advantage is the diversification that an ETF offers, secondary is the relatively low cost involved.
Being a tracker fund – that is, a passively managed fund – ETFs have relatively low expense ratios. This makes them cheaper alternatives to actively managed funds, and better performers, too. Although there is still an unresolved debate over the merits of actively versus passively managed funds, a simple illustration should settle the matter. The S&P 500 has registered a change of *+10.77 percent Year to Date. Not many unit trusts can boast that…
On top of this, an investor can also hedge his holdings in, say, unit trusts by purchasing ‘short’ ETFs that track the index that his cash positions are benchmarked against. Although it can never be a perfect hedge, it is, nevertheless, a cushion against adverse market conditions. There is no need to meddle with futures contracts and be exposed to risks that are involved in leverage. ETF is another way of assessing the index.
The best way to construct a portfolio of ETF is to follow the KISS maxim: keep the portfolio and trading tactics as simple as possible.
Picking just a few ETFs that should beat the broader market while using stops and limits will do the trick. It is always easier to monitor and switch between longs and shorts with a few rather than a lot. ETFs can also play a part in a disciplined investment plan. According to Chong, “Absolute returns regardless of market direction will be achieved by combining and diversifying among long and short (also known as inverse) ETFs.â€
Now the bad news: ETFs are so laden with derivatives that it will make a Collateralized Debt Obligation (CDO) cry in shame…
There are 3 ways an index can be replicated. The easiest is to purchase all the stocks (in its right weightage) in the index. These are the cash-based ETFs. While this is a simple task for a small index such as the 30-stock Dow Jones Industrial Average, it becomes a challenge for one to replicate the S&P 500 and a nightmare for the Russell 2000.
A swap-based ETF is one that replicates the index by holding a basket of stocks that is not related to the index while entering into an agreement (swap contract) with a counterparty to deliver the performance of the index. According to Barclays Global Investors, if the basket of stocks under-performs the benchmark index, the counterparty of the swap contract will have to make up the difference in the under-performance so that the ETF can fulfill its objective of tracking the index. If the reverse should happen and the ETF out-performs the index, then it (the ETF) will have to pay the difference to the counterparty.
With derivatives such as swaps comes counterparty risk. Consider this: An ETF under-performs the index and the counterparty of the swap contract has to make good the difference. What happens if the counterparty defaults? To mitigate this, regulations dictate that the use of swaps – and therefore counterparty risk – be limited to a certain percentage of the fund. Another point to note is that swap-based ETFs also tend to be less transparent. Investors may not have any idea of the details behind the swaps.
Another method of constructing an ETF is through representative sampling. Sometimes it is just not feasible or necessary for the manager to hold all the stocks of an index. The manager need only selects securities that represent the various industries in an attempt to replicate the index without owning all the stocks. Sampling will require the manager to use sophisticated stock optimization process to help minimize tracking error.
Of the 49 ETFs being traded on the Singapore Exchange, about half are swap-based.
Since ETFs are not constructed the same way, risks – other than market risk – are also different between ETFs. Always remember to refer to the prospectus before purchasing any collective investment schemes to fully understand the make-up of the investment scheme. This not only refers to unit trusts but ETFs as well.
===============================
A Portfolio of ETFs
by Andy Chiok
According to Barclays Global Investor, the United States is the world leader in Exchange Traded Funds (ETFs) with assets under management of US$640 billion while Europe comes in at a distant second with US$206 billion of assets. Globally, ETFs stand very close to the US$1 trillion mark, with US$942 billion in assets at the end of October 2009. There are 1,859 ETFs listed in 40 exchanges around the world.
In Singapore, ETFs have been listed on the Singapore Exchange since 2002. In 2009, the Singapore ETF market has hit over S$800 million in turnover and 120 million in volume. As of January 2010, there are 49 ETFs listed covering equities, commodities, fixed income, and money market.
So, why are the majority of investors in Singapore still engaged in stock picking? Why is the financial planning industry here still holding on to unit trusts and not offering clients the benefits of relatively low cost, convenient, transparent, and well-diversified tracker funds that are traded on stock exchanges around the world? When asked if he will be starting ETF investing, a top executive who has been tasked to restructure a local wealth management firm says, “…for now, we will only be looking at unit trusts. Maybe we will be starting ETF trading in the future. But not now.â€
New Independent, a financial planning/ advisory firm in Singapore, has launched ‘wrap accounts’ for ETFs with a product called Fulcrum in 2009. According to Joseph Chong, Chief Executive of New Independent, “Fulcrum (will) allow the investor to go long or short in equities, fixed income, commodities, etc. (It will) allow the individual investor to invest like a hedge fund but with transparency, control, and low cost.â€
Despite all the advantages, the take-up rate is not high. This leaves one to suspect that the bulk of the figure being released by the Singapore Exchange on ETF trading relates to institutional investors. Ignorance on the part of investors and financial advisors (they are insurance agents, after all) and the preference for the familiar may be reasons why ETF is ‘shunned’. There is even a ridiculous boast on an online investment forum of the ability to trade the stock market by observing movements in ETFs!
Which brings us to the question, “What is an Exchange Traded Fund?â€
An ETF is traded over the stock exchange and is bought and sold just like ordinary stocks and shares. It tries to replicate a particular index so buying an ETF is tantamount to buying the entire basket of stocks that are composites of the index. The biggest advantage is the diversification that an ETF offers, secondary is the relatively low cost involved.
Being a tracker fund – that is, a passively managed fund – ETFs have relatively low expense ratios. This makes them cheaper alternatives to actively managed funds, and better performers, too. Although there is still an unresolved debate over the merits of actively versus passively managed funds, a simple illustration should settle the matter. The S&P 500 has registered a change of *+10.77 percent Year to Date. Not many unit trusts can boast that…
On top of this, an investor can also hedge his holdings in, say, unit trusts by purchasing ‘short’ ETFs that track the index that his cash positions are benchmarked against. Although it can never be a perfect hedge, it is, nevertheless, a cushion against adverse market conditions. There is no need to meddle with futures contracts and be exposed to risks that are involved in leverage. ETF is another way of assessing the index.
The best way to construct a portfolio of ETF is to follow the KISS maxim: keep the portfolio and trading tactics as simple as possible.
Picking just a few ETFs that should beat the broader market while using stops and limits will do the trick. It is always easier to monitor and switch between longs and shorts with a few rather than a lot. ETFs can also play a part in a disciplined investment plan. According to Chong, “Absolute returns regardless of market direction will be achieved by combining and diversifying among long and short (also known as inverse) ETFs.â€
Now the bad news: ETFs are so laden with derivatives that it will make a Collateralized Debt Obligation (CDO) cry in shame…
There are 3 ways an index can be replicated. The easiest is to purchase all the stocks (in its right weightage) in the index. These are the cash-based ETFs. While this is a simple task for a small index such as the 30-stock Dow Jones Industrial Average, it becomes a challenge for one to replicate the S&P 500 and a nightmare for the Russell 2000.
A swap-based ETF is one that replicates the index by holding a basket of stocks that is not related to the index while entering into an agreement (swap contract) with a counterparty to deliver the performance of the index. According to Barclays Global Investors, if the basket of stocks under-performs the benchmark index, the counterparty of the swap contract will have to make up the difference in the under-performance so that the ETF can fulfill its objective of tracking the index. If the reverse should happen and the ETF out-performs the index, then it (the ETF) will have to pay the difference to the counterparty.
With derivatives such as swaps comes counterparty risk. Consider this: An ETF under-performs the index and the counterparty of the swap contract has to make good the difference. What happens if the counterparty defaults? To mitigate this, regulations dictate that the use of swaps – and therefore counterparty risk – be limited to a certain percentage of the fund. Another point to note is that swap-based ETFs also tend to be less transparent. Investors may not have any idea of the details behind the swaps.
Another method of constructing an ETF is through representative sampling. Sometimes it is just not feasible or necessary for the manager to hold all the stocks of an index. The manager need only selects securities that represent the various industries in an attempt to replicate the index without owning all the stocks. Sampling will require the manager to use sophisticated stock optimization process to help minimize tracking error.
Of the 49 ETFs being traded on the Singapore Exchange, about half are swap-based.
Since ETFs are not constructed the same way, risks – other than market risk – are also different between ETFs. Always remember to refer to the prospectus before purchasing any collective investment schemes to fully understand the make-up of the investment scheme. This not only refers to unit trusts but ETFs as well.
