Word in the New$: ETF

Apr 09, 2017 05.00PM |
 

By Ryan Ong

ALTHOUGH they’ll never admit it, a large part of the finance industry aim to convince you that what they do is very complicated, and impossible to understand for anyone short of a NASA scientist (that’s why you better pay them to manage your money for you). Over the past two decades, one of their secrets has been the ETF – a straightforward financial product that makes them look like geniuses, while actually proving the opposite. You should at least have a basic grasp of the concept:

We have the first Asia ex Japan REIT ETF whatsit, and what the heck does that mean?

It’s called the NikkoAM-StraitsTrading Asia ex Japan Real Estate Investment Trust (REIT) Exchange Traded Fund (ETF), because that kind of word salad convinces your brain to just give up and trust the person selling it. It is listed on the Singapore Exhange (SGX) on March 29 this year, and is the first of its kind.

Before we go further into this, we should probably explain what the hell an ETF is.

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What is an ETF?

ETFs have become some of the most popular and successful investment products over the past 20 years. Like a traditional investment trust, ETFs are investment companies that buy and sell assets on behalf of a pool of investors. However, ETFs tend to be much cheaper (in terms of fees) than other types of trusts, because of the way they manage the portfolio.

In traditional investment companies, such as actively managed mutual funds, there is a manager who tries to outperform the market (i.e. get you higher returns than anyone else) by cleverly buying and selling assets at the right time.

This is the method that made people like Warren Buffet and Anthony Bolton successful, and the same method can work for anyone, provided they are Warren Buffet or Anthony Bolton. What we’re trying to say is, when other people use this trick of trying to time the market (buying and selling assets at the right time), the result tends to – as we technically call it in finance – suck ass.

It’s also terrible for investors, as fund managers pay themselves bonuses and salaries for managing the portfolio, even if it crashes.

Sometime in the 1990s, a new method was developed to get around that. The idea was that, instead of relying on a fund manager’s skill, one could build a portfolio that simply duplicates a particular index – an index like the Straits Times Index, the Financial Times Stock Exchange 100 Index (United Kingdom), or the Dow Jones Industrial Average (United States of America) for example. As the index rises or falls, the portfolio would mimic the movements.

Since the said index tends to rise over the long term, it could potentially deliver equal or better returns than actively managed funds – but minus the cost of a fund manager: you just need a computer to buy and sell the assets to mimic the index. There’s no need to make predictions or time the market.

Even better, the portfolio would be diversified (spread out over many different kinds of businesses). While some of the assets may underperform, the other assets may do exceptionally well and offset the former.

Fast forward to today, and you have the ETF. One of the long time examples in Singapore is the Straits Times Index Fund (ST Index Fund), which tracks the movement of the top 30 blue chip companies.

Now there are actually different kinds of ETFs, from full physical replication to synthetic; there are even inverse ETFs, which deliver a mirror opposite of how the index moves (it goes down when the index goes up, and vice versa). But you don’t need to go that far. The main concept to grasp is that ETFs mimic the movement of a particular index, and have lower management costs because there isn’t an expert trying to guess when to buy and sell. ETFs also automatically diversify your investment, because your money is used to buy a portion (a unit) in a basket of different assets.

As a final point of difference, ETFs are called “exchange traded” because you can freely buy and sell units in the fund.

With most traditional funds, you can’t just buy or sell units whenever you like; there are rules, such as limits on how many units investors can sell at once. With ETFs, units in the fund are treated like shares; you can buy and sell them on the stock market with a few mouse clicks.

Now, going back to the first Asia ex Japan yadda yadda ETF…

The NikkoAM-StraitsTrading Asia ex Japan Reit ETF, like any ETF, tracks a particular index. That index is called the FTSE’s EPRA/NAREIT Asia ex Japan Reits Net Total Return SGD index. There is no acronym for this, because FTSEEPRA/NAREITAJRNTRSGDI is not any easier to pronounce or remember.

A Real Estate Investment Trust (Reit) is a company that buys and rents out buildings, and then pays out the collected rental income to investors as dividends. The Asia ex Japan Reit ETF is an ETF, that mimics the movement of the various Reits: 70 per cent of which are Singapore-listed Reits, and the remaining 30 per cent of which are Reits listed in Hong Kong and Malaysia.

As those Reits do better, investors in the ETF will get higher returns (and the reverse is also true). This is an interesting new product, because it is usually hard to decide what kind of Reit you want. There are Reits that focus on hotels, there are Reits that focus on malls, there are Reits that focus on residential properties, and so forth. By buying one ETF that tracks these various Reits, you can diversify your money across all of them.

Is it a good financial product?

Ha ha, you almost thought you got me eh, MAS? Well I’m not recommending anything. You readers can ask your wealth managers (or whoever you trust) whether this is a good buy. But I’ll add one thing:

You should know that some professionals in the finance industry loathe ETFs. Many of them make oodles of money from selling their expertise, and charging to manage your portfolio. They are strongly against the concept of just mimicking an index, just like they are strongly against the concept of you not paying them. That’s not to say that one or the other is good or bad – you just have to remember that they are natural enemies.

 

Featured image by Sean Chong.

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