Increasingly, Exchange Traded Funds (ETFs) are being touted by financial journalists, bloggers and other cool kids as the low-cost, anti-establishment investment that you ‘just gotta have’.
ETFs are listed investment products that track the performance of a group or “basket” of Shares, Bonds or Commodities. These “baskets” are known as indices. An example of an index is the FTSE/JSE Top 40 Index. An ETF can be bought or sold in the same way as an Ordinary Share.
Indeed, in the US and many other markets, ETFs have made massive inroads with investors. It is estimated that ETFs make up as much as 13% of all fund assets in the US (and growing quickly).
This is not the case in South Africa. At R237bn, the entire rules-based market (which is what passive investing – including ETFs and index tracking unit trusts – is increasingly being referred to as) made up around 4% of the over R4 trillion assets under management of the total South African investment market (excluding PIC assets) in 2018. Rules-based strategies made up a similar percentage in the Collective investment Scheme (CIS) industry (R98 billion out of R2.6 trillion).
When you look at ETFs alone, the situation is even more dire. In 2018, ETFs made up less than 2% of the whole CIS industry.
In fairness, the assets under management of the rules-based market has seen considerable growth in South Africa. Measured against the CIS industry growth of 15% p.a. over the past seven years, the rules-based market has grown at 24% p.a.
Nevertheless, it is clear that South Africans are not flocking into ETFs at the same rate as those in many other parts of the world.
Here are a couple of key reasons why this could be the case.
They have an advisor problem
In the US, the share of financial advisors recommending investments in ETFs increased from 44% in 2008 to 87% in 2018. In South Africa that figure is likely to way, way lower.
According to Craig Gradidge of Gradidge Mahura Investments, a lot of investment business is placed via linked investment service providers (LISPs), where advisers can blend various asset managers together in one product. “Because ETFs are essentially shares, it was administratively difficult to include them in client portfolios as LISP systems were not designed to combine shares and funds together in a portfolio. The delay in getting more and more ETF providers to offer CIS wrapped solutions was part of the reason for the slow uptake. They took a bit long to understand the importance of distribution and access.”
Gradidge adds that some ETF providers initially took a very divisive approach when it came to their marketing message. “This created resistance within the advisory sector as many saw indexing as competition.”
He says that while adviser commissions / fees are not impacted by the inclusion of index tracking solutions (in fact index solutions help reduce the overall cost to clients and are therefore attractive to advisers), the debate around active vs passive has been harmful in that it has almost forced people to take sides.
Poor marketing and administration
Anyone who has worked in marketing in South Africa knows that asset managers and unit trust providers are some of the country’s biggest spenders on advertising, PR and other brand building activities.
While some of this spend is wasteful, there is no doubt they have built up huge brand recognition and trust amongst millions of investors.
These companies have also spent years showcasing their talents and knowledge of the market to advisors, many who have become a little star struck and in awe of top fund managers.
In contrast, how many regular investors in South Africa even know what an ETF is, let alone can name any companies that offer them. I’m not saying they need to spend millions on fancy television adverts, but there is no doubt they can do a lot better in spreading their message amongst investors and advisors.
Then there is the administration problem. Being an investor myself in locally domiciled ETFs (through the ETFSA platform), I can attest to the fact that the administration can be less than ideal.
Very recently, I issued a redemption instruction for about R500 000 from one of the ETFs on the ETFSA platform (administered by AOS Online). This process normally takes around 5-7 working days, but after 16 working days I had still not received any proceeds. When I queried this delay, I received an email saying there had been a “glitch” in the system and that it was being resolved. It took another two weeks and several more requests before I finally received all the funds. Not good enough at all.
Lack of multi asset ETF solutions for retirement funds and offshore investing
Gradidge says that while some investors are aware of ETFs, they aren’t always aware of where and how to incorporate them into their portfolios.
According to Jannie Leach, Head of Core Investments at Nedgroup investments, the vast majority of ETFs are single asset class solutions. “With the implementation of the ‘look-through principle’ for all retirement savings, individuals can’t only use full equity portfolios in the retirement saving annuities and preservation funds and hence are compelled to use funds that are compliant with Regulation 28 of the Pension Funds Act. This makes it difficult to use most of the index products available because the investor needs to do their own asset allocation.”
He says multi-asset rules based unit trusts and ETFs have been introduced to the market over the past couple of years.Almost all of the assets (R27bn) are in unit trusts, rather than ETFs.
One of the reasons for this is that of the handful of multi-asset ETFs available in South Africa, few offer global multi-asset exposure. The best range of options I could find online was itransact, which offers six multi asset ETFs with global exposure.
Performance issues in SA
According to Andrew Bradley of Fiscal Private Client Services, many active managers in SA performed better than the index in the boom times for ETF’s globally.
“This was due to the SA index distortion with resource securities. For many years the active bet in SA had been over/under weight resource stocks being the differentiator, and under-weight being the big winner. Also, as a slightly less efficient market, it was a bit easier for active managers to add value. These factors no longer exist, but the perception of the SA ETF market performance is behind the curve because of this.”
Fees – not always the cheapest
There is a lot of debate around the cost comparison between ETFs vs passive unit trusts. There can be no doubt that most ETFs that track local indexes have cheaper ongoing fees than their unit trust counterparts.
However, it is important to factor in transaction related expenses when calculating total costs for ETFs. Unit trusts only incur transaction costs inside the fund structure whereas because ETFs are traded on an exchange, they incur an additional acquisition cost to buy or sell which is not disclosed under the ETF’s total investment charges. Then there are the ‘spreads’ between bid and offer prices on ETFs, which can also be seen as an additional acquisition cost to the investors as this is where market-makers are remunerated.
Finally, because they do not yet have critical mass, the fees charged by ETFs that track global indexes are more expensive than you would imagine. For example, the Sygnia MSCI World Index ETF has an annual fee of 0.68%. That is without the transaction related expenses incurred when buying and selling the ETF.
That is way more expensive than the equivalent ETFs available offshore through companies like Vanguard, which charge as little as 0.1% to access the MSCI World Index. It’s also not much of a cost advantage over some of the passive (and even active) global unit trusts available in SA.
No South African tax advantage for passive investors
One important difference between the US and South African investment contexts is that ETFs – a popular passive vehicle in the US – enjoy a substantial tax advantage over actively managed unit trusts. This arbitrage has been one of the key drivers of the US move towards ETF investments. However, according to Leach, this advantage does not exist in South Africa, where the two are subject to identical tax treatment. This makes for a less compelling case for local investors to use ETFs compared to the US.
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