Suitability: Foreign investment has always been popular among South African investors. It provides a good way to diversify a portfolio, limiting concentration risk for investors overly exposed to the South African market. So in today’s note and the next two weeks, we focus on ETFs that South African investors can use to gain offshore exposure.
The argument for adding foreign assets to your portfolio is strong. With SA representing a tiny proportion of the global economy, restricting your portfolio to local assets means foregoing investment opportunities in the global market. Offshore investing opens a much wider investment universe with access to sectors underrepresented on the JSE. It also enables you to hedge your portfolio against domestic economic and political risks, including a weakening rand.
South Africans have a number of options for adding foreign assets to their portfolios. You can do it through unit trusts, investing in stocks with foreign operations, locally listed holding companies which invest in offshore assets, or by utilising your annual investment allowance to invest directly into foreign companies. None of these options, however, will beat ETFs in terms of costs and diversification. Click here to find out general information and benefits of ETFs.
This week we focus on the x-tracker MSCI USA ETF offered by Deutsche Bank. It is suitable for investors wanting exposure to the US market. While diversified, it is fully invested in equities and is exposed to currency volatility, so invest in this fund only if you can tolerate risk.
What it does: The fund tracks the MSCI USA index by physically holding stocks in the same weightings as the index. The MSCI USA index is a capped index that is designed to measure equity performance in the US, representing 626 of the biggest listed companies in the US with a total market capitalisation of approximately US$14 trillion. The index covers about 85% of the free float-adjusted market capitalisation of the US equity markets. Free float means they exclude shares held by strategic investors such as governments, corporations, controlling shareholders and management, as well as shares subject to foreign ownership restrictions. This ensures that the fund invests in the most liquid stocks.
Advantages: The main attraction of this ETF is that you can invest in international stocks without the hassle of externalising capital. By buying just one rand-denominated unit of the ETF you have access to a broad spread of US equities. Also, while registered in the US, most of the stocks tracked by this fund are multinationals with business interests that span various continents, generating earnings in multiple currencies.
Top holdings: The top 10 holdings of this fund are dominated by technology companies. Given the limited number of technology stocks on the JSE, this is an advantage for most local investors. No single asset has a disproportionate influence on the portfolio, with the largest exposure being 3% invested in Apple.
Historical performance: The fund’s performance depends on how you invest – through a single lump-sum payment or regular payments. A lump-sum investment (which tracks the index’s movements more accurately) of R1 000 made five years ago would be worth R3 377.33 today. The table below reflects the fund’s historical returns in percentage terms for a lump-sum investment.
Fundamental view
By investing in this ETF you are investing in the underlying portfolio of equities and taking a short position on the rand. Your ultimate return will be influenced by the movement of the rand against the dollar as well as the share price movements of the underlying companies. A weakening of the rand against the dollar will be good for this ETF as it will mean higher dividends and also higher net asset value of capital invested. Any strengthening of the rand will, however, be bad news for your investment.
As can be seen on the table below (column 4), the performance of this fund over the past five years was driven more by the depreciation of the rand against the dollar rather than by the actual movement in stocks. For instance, over the past 12 months, the underlying stocks in dollars declined 0.85% but after converting into rands, the fund gained 21.89%. While this might seem an attractive feature particularly now when the future of the rand looks uncertain, you must be aware that the movement of the rand in the opposite direction could significantly damage returns. This fund should therefore be used as a long-term investment mainly to diversify your portfolio rather than trying to make bets on the rand.
BACKGROUND: Exchange traded funds (ETFs)
Exchange Traded Funds (ETFs) are passively managed investment funds that track the performance of a basket of pre-determined assets (in this case, industrial companies). They are traded the same way as shares and the main difference is that whereas one share gives exposure to one company, an ETF gives exposure to more than one company in a single transaction. ETFs can be traded through your broker the same way as shares, say, on the Easy Equities platform. In addition, it qualifies for the tax-free savings account, where both capital and income gains accumulate tax free.
Risk: This is a pure equities investment, so the performance is likely to be volatile. Investment in this fund exposes you to a number of risks including, general market risks, exchange rate risks, interest rate risks, inflationary risks, liquidity risks and legal and regulatory risks.
Fees: For the year to end-March, 0.86% of the average net asset value of the portfolio was incurred as charges, levies and fees related to the management of the portfolio. While this is slightly elevated compared with most local equity ETFs, it is far lower than what one would incur using other means of gaining offshore exposure.
Benefits of ETFs
- Gain instant exposure to various underlying shares in one transaction
- They diversify risk because a single ETF holds various shares
- They are cost-effective
- They are liquid – it is usually easy to find a buyer or seller and they trade just like shares
- High transparency through daily published index constituents
You can check out other ETF Tuesday posts here.
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