Pittwater Life November 2017 Issue

Business Life: Money
Business Life
Running the rule over
Exchange Traded Funds
Iwrite this on the anniversary
of the October 1987 stock
market crash – or ‘Black
Monday’. Back then I was a
21-year-old with barely two
years of work experience and
no real concept of what was
happening to the markets or
people’s wealth at the time.
In the 20-year period
spanning Black Monday to
what history now refer to as
the Great Recession (the period
between 2007 – 2010) not much
other than the development
of electronic trading really
changed the nature of our local
stock market.
Since the Great Recession,
however, our markets have
become home to a breed of
products that have altered the
nature of investing and portfolio
construction. Exchange traded
funds (ETFs) have been a feature
on American exchanges since
the launch of an S&P 500 fund
in 1993 but it wasn’t until
the passing of the GFC that
local investors started to seek
out ASX-listed ETFs and the
manufacturers of ETFs started
developing a wider range of
products.
The reason for this wave
of interest had had several
important parts to it:
Cost – ETFs in the main are
based on relatively low-cost
index funds listed on the ASX
and post GFC people were
looking at ways of reduce the
cost of investing.
Administration – being
listed on the ASX they could
be transacted easily and
electronically from any broking
account.
Democratisation of the
stock market – along with the
advent of low-cost electronic
trading investors saw that many
active fund managers fared no
better than index funds during
the GFC so why pay a fund
manager a fee when a cheap
index fund would do the job.
Diversification – the
purchase of a single ETF share
brings instant diversification
with up to the entire market
underlying a single share
purchase.
Tax structure – ETFs that
represent indexes tend not
to be as frequently traded as
active managed funds which
can reduce the amount of
distributable capital gains
– something that generally
bothers investors outside of
super funds.
We have had ETF-like
securities listed on the
Australian exchange for many
years before we saw the rise
of ETFs in the post-GFC era.
Investors would have known
these as Listed Investment
Companies or LICs. There
are several key differences
between the two including
a fundamental issue of legal
structure but the main one was
a tendency for LICs to trade at
a discount to their net asset
value (NAV). This often has to
do with restrictive management
agreements embedded in LICs
but it mainly has to do with
the key ETFs having a market
with Brian Hrnjak
maker that stands in the market
providing liquidity and allowing
them to trade close to their NAV.
So how can you use
ETFs to enhance portfolio
construction?
Geographic diversification:
You can hold the wider
investable Australian market by
owning a single share in an ASX
300 Fund as easily as you can
own a share in a US based S&P
500 Fund, a Euro market Fund or
a Japanese Fund.
Company size
diversification: You can
purchase shares in ETFs that
track large or small, global or
local companies.
Industry diversification: You
can purchase shares in ETFs that
focus on particular industries,
such as one that tracks a Nasdaq
index following shares in cyber
security companies.
Diversification into
commodities: You can buy
an interest in gold, crude oil
or agricultural commodities
through an ETF.
Diversification into
currencies: You can buy
exposure to UK Pounds, Euros or
US Dollars via an ETF.
Gearing: You can buy ETFs that
contain internal gearing that will
disproportionately profit if the
market rises (the opposite if it
falls!) or short based ETFs that
will profit if the market is falling.
So, like the US, our listed
market is moving down a path
50 NOVEMBER 2017
The Local Voice Since 1991