Investors have been warned that they could expect lower returns in the coming years. In this low-yield, low-return environment, they would need to reconsider not only the vehicles in which they keep their money but also the cost of doing so.
Hedge funds that charge management fees of 1% to 5% and performance fees of 10% to 20%, as well as unit trust funds that have upfront sales charges of 3% to 5% and annual management fees of 1.5% to 2%, are coming under close scrutiny as many of them have underperformed the market in the past few years.
The current consensus on the future direction of the capital markets makes the cost of investing an even more pertinent issue. Hence, investors are increasingly on the lookout for low-cost investment vehicles that do not erode their returns, especially those planning for retirement.
Phil Stockton, director and co-owner of Private Capital Ltd in Hong Kong, says investors should be allocating more of their portfolios to exchange-traded funds (ETFs) in this environment. “Logically, when we are facing modest capital market assumptions, it follows that active managers will be hard-pressed to deliver value for their fees. The hedge fund industry in particular looks very expensive in this context.”
On the other hand, if one buys into the low-cost MSCI World Equity ETF, the worst that could happen to an investor is getting the total market return minus the total expense ratio (TER) and any platform costs, such as brokerage fees, says Stockton. “As an investor myself, I would take this [low-cost approach] rather than risk my retirement funds with an active fund manager who thinks he can beat the market. Empirical evidence tells us this is not the case.”
Private Capital is a fee-based, commission-free investment management and financial planning firm. It is registered with the Securities and Futures Commission of Hong Kong.
Aw Choon Hui, deputy CEO of GYC Financial Advisory Pte Ltd in Singapore, says ETFs are a great fit for one’s long-term investment plan as they represent a huge chunk of the investible market. “As frequent trading does not benefit investors in the long run, we only consider ETFs for short-term trading opportunities if they are of the more esoteric nature, such as volatility or leveraged shorts on certain asset classes.”
Aw believes that the shift to low-cost investing is gathering speed as investors are becoming more well-informed and educated. They are also starting to realise that they can enhance their investments via low-cost instruments because a lot of the high-cost investment products did not work well for them.
GYC Financial Advisory is an independent financial advisory firm unaffiliated with any financial institution. It is registered with the Monetary Authority of Singapore.
Robert Foo, managing director of MyFP Services Sdn Bhd, says the low cost of ETFs makes them a great retirement planning tool. He adds that the firm has been allocating a portion of its clients’ portfolios to ETFs for quite some time now.
“Compared with unit trust funds, ETFs are a much cheaper alternative. For offshore ETFs, such as those of Vanguard or iShares, the transaction fee is as low as 0.07% as they have to be competitive,” says Foo, adding that investors also pay a brokerage fee of 0.1% to 0.7%, depending on who the broker is.
Foo says the firm has seen a heavy shift to ETFs over the years and that they now make up more than 90% of its clients’ portfolios. MyFP Services is an independent fee-based financial planning firm licensed by the Securities Commission Malaysia.
Mahdzir Othman, CEO of i-VCAP Management Sdn Bhd, says ETFs can generate stable returns over the long run with minimal hassle and at a cost-efficient rate if investors are savvy enough in terms of market timing and the type of ETFs they choose. “As an ETF’s objective is to closely track the performance of its benchmark, investors have full control of their investment and enjoy lower risk, depending on the type of underlying securities or assets, due to its transparency.”
Around the world, ETFs are becoming popular among investors. PwC says in its latest report, ETFs: A Roadmap to Growth, that it expects accelerated growth in these funds in the next five years, with global assets under management (AUM) expected to exceed US$7 trillion by 2021. Of this figure, Asian firms are expected to see an annual growth rate of 18%. According to the report, which was released in July, the growth drivers of ETFs in the Asian market are the use of ETFs in retirement planning, improving investor education and growing distribution channels.
In addition to their low cost, top-performing global ETFs have delivered stellar returns as their underlying indices recover from the losses of recent years. According to Morningstar, the leading ETFs in the large growth, large value, mid-cap growth, mid-cap value, small growth and small value categories saw returns of 120.52%, 42.22%, 106.94%, 52.89%, 150.58% and 48.05% respectively for the 12 months ended Oct 5. By comparison, the top-performing US mutual funds in the same categories provided returns of 20.74%, 25.69%, 19.62%, 27.37%, 30.03% and 33.91% respectively.
There are eight ETFs in Malaysia, two of which are issued by CIMB-Principal Asset Management, two by AmInvestment Services and the rest by i-VCAP Management. They have different exposures in terms of geography and sectors. Some track local indices while others track regional ones.
According to The Edge-Lipper Fund Table, local ETFs have seen mixed performance over the years, but many of them continue to give higher returns than a significant portion of the unit trust funds in the same category (see table).
The fees for investing in these ETFs are significantly lower than those for unit trust funds. For example, i-VCAP Management’s MyETF Thomson Reuters Asia Pacific Ex-Japan Islamic Agribusiness carries a management fee of 0.75%, trustee fee of 0.045% and index licence fee of 0.05%.
“The TER of our ETFs ranges from 0.5% to 0.7%, making them much more tolerable than unit trust funds. The TER of unit trusts would be about 1.6%, excluding the upfront sales charge. Investors should take this into consideration before making an investment decision,” says Mahdzir.
However, there are some challenges when it comes to investing in local ETFs, says Foo, as there are only eight in the market and they charge a higher transaction fee than their offshore counterparts, some of which charge as low as 0.07%.
How to choose ETFs
GYC’s Aw suggests a broad allocation of ETFs for investors to consider as building blocks for their long-term investment plan. “We like the Vanguard Total Stock Market (VTI: US) as it tries to capture the entire US equity market at a very low cost (0.05%). The Vanguard Total Bond Market Index Fund (BND: US) is good at capturing the broad investment-grade fixed-income market in the US, which includes treasuries, mortgage-backed securities and credit. The iShares MSCI ACWI ETF (ACWI: US) is good for a global equity allocation as it includes emerging markets and Asia-Pacific in a single fund,” he says. VTI: US and BND: US are listed on NYSE Arca while ACWI: US is listed on Nasdaq GM.
Private Capital’s Stockton has ETF holdings in Vanguard and iShares. He says if a target-date ETF or index fund is not available, one can use ultra-low-cost ETFs to get the appropriate risk-adjusted exposure via the MSCI World, S&P 500 or Emerging Market Equities indices. Investors can get bond exposure via the Total Bond and Emerging Market Bond indices.
Some of the ETFs Stockton mentions, such as the iShares MSCI Emerging Asia Index ETF and Vanguard S&P 500 Index ETF, are listed on the Hong Kong Stock Exchange while others are mainly listed in the US. He thinks there are enough ETFs to choose from in the market. However, in certain regional markets, there is a bias towards “home” or regional exposure. Some providers, such as Vanguard and iShares, have a very small presence in markets such as Hong Kong.
“Institutional investors can use ETFs listed overseas, but retail clients are often restricted to those listed on their domestic exchanges. This situation has seen some improvement but it is still a cause for frustration,” says Stockton.
“What we also need is better distribution of ETFs. In markets such as the UK, the US, Australia and New Zealand, there are multiple wrap platforms for investors to use. This is essential for price competition and innovation. One can have access to the lowest cost ETF available but if the implementation cost is high, the low-cost benefit is eroded.”
MyFP Services’ Foo says there are thousands of ETFs tracking a wide range of asset classes for investors to choose from. However, investors should not compare the performance of local ETFs to their offshore peers as the funds have different exposure or may be tracking different indices. He thinks this is where investor education is needed.
What should investors look for when choosing ETFs? Mahdzir says past performance aside, investors should pay attention to the tracking error of an ETF as it is an indication of whether the fund is tracking the index closely. “A good ETF should track the underlying index as close as possible. Our ETFs have a tracking error of less than or about 1%. The general rule is that a tracking error of less than 3% is acceptable for tracker funds like ETFs.”
Tracking error is the difference between the returns of the tracker fund and the underlying index. It is essential for an ETF to have a minimal tracking error as it means the returns of the ETF would not be too far off from the performance of the index it tracks.
GYC’s Aw says the company prefers a mix of ETFs, select actively managed funds, low-cost mutual funds and risk-managed funds when building out a portfolio. This approach helps to extend the efficient frontier in portfolio construction and gets the best risk/return ratio.
“It really boils down to the amount of losses an investor can take and the best risk-adjusted return the manager can give to clients after constructing the portfolio with the various ETFs and funds. We prefer to allocate differently from the rest of the market and not commingle all the different assets into one portfolio,” he adds.
Gaining traction in Asia-Pacific
ETFs have seen significant growth in the last 10 years. According to London-based independent research and consultancy firm ETFGI, assets invested in ETFs and exchange-traded products listed around the world reached a record US$3.34 trillion at end-July. Jackie Choy, Morningstar Asia’s director of ETF research, says ETFs have started to gain traction in Asia-Pacific too.
“For Asia-Pacific, the AUM for ETFs grew 20% to US$296 billion for the 12 months ended June. There are different dynamics for different countries. In the past 12 months, significant growth has come out of Japan. Its AUM grew 23% to US$146 billion,” he adds.
The key driver of the growth in Japan, he says, was government initiatives. The Bank of Japan uses ETFs as part of its quantitative and qualitative monetary easing programme. The central bank announced in July that it would double its rate of ETF purchases to an annual pace of US$59 billion as part of its efforts to expand monetary stimulus.
Is the growth in the AUM of ETFs a result of the decline in the AUM growth of mutual funds? Choy says this is the case in the US, but it may not be true in other countries. “In the US, we have been seeing net outflows from actively managed funds and net inflows into passively managed ones. For the other regions, we haven’t seen that trend.”
He believes robo-advisory firms will help ETFs see more growth in Asia as they are a natural tool for a robo-advisory portfolio. However, this segment is still new in Asia and international players have yet to enter the region.
When it comes to ETFs, Choy says different countries are at different stages of development. The ETF market is less mature in Asia, he notes, making product development an important issue in the region.
ETFs and unit trusts on the same playing field
US-based independent investment research and management firm Morningstar announced in early September that it was putting exchange-traded funds (ETFs) and open-end mutual funds into the same peer group in fund ratings. It will also provide forward-looking Morningstar Analyst Rating methodology for ETFs, just like it does for mutual funds.
Research firms such as Thomson Reuters Lipper have been comparing these two types of funds for quite some time now. Why is Morningstar making the move?
Jackie Choy, Morningstar Asia’s director of ETF research, says the firm has noticed that investors increasingly see open-end funds and ETFs as interchangeable options when choosing investments. “We have been providing qualitative research and analyst reports on ETFs for more than eight years. Applying our globally consistent Morningstar Analyst Rating methodology to these mainly passive investments is a natural extension of our research process.”
What does this mean for ETF players, unit trust fund managers and investors? Choy says assigning the qualitative rating model to ETFs will help investors assess their prospects based on the fundamental research its analysts conduct. The enhancements will better support advisers and other financial intermediaries.
“Being in the same playing field, mutual fund companies should be more aware that open-end funds and ETFs are interchangeable options when choosing investments. For investors, they will be able to use the same lens from Morningstar when assessing mutual funds and ETFs,” he adds.
Choy says the Morningstar Active/Passive Barometer — Midyear 2016 report shows how actively managed funds in the US performed compared with their passively managed counterparts. It finds that actively managed funds have generally underperformed their passive counterparts, especially over longer time horizons, and experienced higher mortality rates.
“The report finds that failure tended to be positively correlated with fees. The higher-cost funds were more likely to underperform, be shuttered or merged away while lower-cost funds were likelier to survive and enjoy greater odds of success,” he adds.
i-VCAP to promote local ETFs
Exchange-traded funds (ETFs) could be a great investment planning tool for investors. The first Malaysian ETF — the ABF Malaysia Bond Index Fund, issued by AmInvest Management Bhd — was set up in 2005. The first Malaysian shariah-compliant ETF — the MyETF Dow Jones Islamic Malaysia Titans 25, issued by i-VCAP Management Sdn Bhd — was set up in 2008. Why are so many investors still unaware of this option?
Mahdzir Othman, CEO of i-VCAP Management, acknowledges that few activities have been carried out over the years to promote ETFs. However, as more investors realise that unit trusts are not their only option and begin to show interest in ETFs, things are expected to change.
“We set out to ramp up efforts to reach out and inform investors through participation in roadshows and other on-the-ground marketing activities for retail investors as well as private sessions with institutional investors. As the largest shariah ETF issuer in the world, our shariah-compliant MyETF series is an attractive option for those who are interested in socially responsible investments that can provide stable returns in the long run,” he says.
i-VCAP is working with the relevant parties to see increased trading liquidity for ETFs on the stock exchange while engaging institutional investors to participate via creation and redemption activities that are more seamless and efficient. The company currently manages four shariah-compliant ETFs.
The MyETF Dow Jones Islamic Malaysia Titans 25, MyETF MSCI Malaysia Islamic Dividend and MyETF MSCI Southeast Asia Islamic Dividend provided returns of 4.34%, 9.95% and -5.32% respectively for the year ended Sept 23. The MyETF Thomson Reuters Asia Pacific ex-Japan Islamic Agribusiness, which was launched in November last year, saw a return of 5.72% for the six months ended Sept 23.
So far, ETFs have been gaining traction in Malaysia. Last year, the Malaysian ETF market saw its total volume traded on Bursa Malaysia grow 71% to
RM29.8 million from RM17.4 million in 2014, says Mahdzir. As at end-July, the industry’s total AUM had grown to RM2.2 billion.
Mahdzir hopes that as the local financial advisory industry moves away from commissions to being fee-based, more financial advisers and planners will promote ETFs to their clients. “We have seen similar cases in the US, Europe, Australia and India. ETFs gained higher traction when they turned into fee-based advisories,” he says.
“Typically, when investors buy into actively managed funds such as unit trusts, investors are relying on the fund managers’ skills to beat the market. However, despite beating the market, the high sales charge/commission and management fee often eat into the net investment return of investors. The advisory fee structure, therefore, provides a fairer arrangement for investors, for which financial advisers will provide better value-added services and pick the right products for the benefit of investors.”
On the other hand, he adds, ETFs have an equal chance of giving decent returns without the high cost. Financial advisers may start to advise clients on buying into various ETFs and unit trusts for a better chance of generating higher returns.