Intellidex: An introduction to exchange-traded funds

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The key to wise investing is diversification. Spreading your investments between various exposures ensures the best balance of risk and return. Exchange-traded funds (usually just called ETFs) provide the cheapest and easiest way to do that. They’re so efficient that National Treasury has decided they are the right instruments to use for tax-free savings accounts (TFSAs) offered by stockbrokers. There are currently 45 of them available on the JSE, though not all are eligible for TFSAs.

Building a portfolio of ETFs is the best way to use your TFSA – low-cost portfolios plus you don’t have to pay any tax on your returns!

Of course, it’s important to remember that investing involves risk. You could lose your money. But, in the long run, equities have proven to be a better source of return than almost any other investment strategy.

Investing in funds is nothing new. South Africa has a long history of unit trusts (which are now usually called “collective investment schemes”). ETFs provide much the same kind of service, but are usually cheaper and also much easier to buy into and sell out of.

The key difference between an ETF and a unit trust is that ETFs are listed on the JSE so you can buy or sell them just like a share. That means the prices are visible all day and the only cost you incur in buying them is the brokerage you pay (with EasyEquities that’s a market low of 0.25%). In contrast, unit trust prices are only set at the end of the day and you usually have to pay an upfront fee of up to 3.5% when you invest plus an ongoing fee that can be as high as 2% each year. ETFs have an annual fee imbedded in them, but for local assets that’s usually less than 0.5%.

The other major difference is that ETFs are usually “tracker funds” so they track a basket or index. Unit trusts are often actively managed, so a fund manager is making decisions over which stocks to invest in. You may think that means returns will be better, but plenty of studies show that in the long run actively managed funds tend to return the same as the whole market, but fees mean the net return is lower. ETFs give you a much cheaper way to track the market as a whole.

The available ETFs can be broadly split into two types of assets, called “asset classes”. These are equities and commodities. Equities are the shares of companies and those ETFs invest in a portfolio of them, using an index. Among the most popular are funds that track the JSE’s Top 40 index. These invest in the 40 biggest JSE-listed companies according to market capitalisation (which is the total value of the companies’ shares), with the bigger companies having a larger weighting.

Then there are ETFs focusing on specific sectors such property companies, industrial or financial stocks. Some even focus on investment themes such as growth stocks (fast-growing companies) or lower-risk shares with low volatility. There are even ETFs for offshore investments that track the biggest companies listed on stock exchanges in Europe, the US, UK and Japan.

In South Africa you can also obtain ETFs that invest in commodities like gold, platinum and palladium, though these are not currently available to hold through TFSAs.

Purple Group Limited has teamed up with research house Intellidex to bring you top quality research on ETFs available in South Africa. We’ll be bringing weekly insights to you from now on, to give guidance on which ETFs may be best for your investment objectives.

The full list of ETFs trading on the JSE: