July 3, 2010
By Neesa Moodley-isaacs
The choice of passively managed exchange traded funds (ETFs), particularly those that track indices and what amounts to derivatives of those indices, is becoming increasingly more complex.
Nedbank recently launched its BettaBeta Equally Weighted Top 40 ETF with the result that there are now four ways in which you can track the fortunes of the top 40 companies listed on the JSE.
ETFs that in one way or another track the FTSE/JSE Top 40 index are the Satrix 40, the Satrix Swix, and the Satrix Rafi 40. There is also the Old Mutual passively managed unit trust fund, the Old Mutual Rafi 40.
The BettaBeta ETF invests in the same shares as the Top 40 index, but changes the weightings of the companies in the fund so that each company has a weighting of 2.5 percent, Nerina Visser, the head of Beta Solutions at Nedbank Capital, says. This means that each share contributes equally to the performance of the fund, regardless of the share's sector, number of shares in issue or price.
The Top 40 index is heavily skewed towards companies in the resources sector, because the weighting of shares in the index is determined by their market capitalisation (see "Indices reflect bundles of securities", in related article below).
"Unfortunately, this means that instead of owning a diversified portfolio of shares, Top 40 index investors often inadvertently find themselves over-exposed to a few large South African mining companies," Visser says.
However, Brett Landman, the chief executive of ETF platform Satrix, has a different view. He says the Satrix 40 ETF is representative of the South African equity market and, because it is market-cap weighted, should require less rebalancing and portfolio churn.
Landman says an equally-weighted ETF distorts the reality of the South African equity market. It is also likely to require more rebalancing and, consequently, should incur higher costs, which will have a drag on performance, particularly in the long term.
He says an equally weighted ETF also introduces significantly more liquidity risk because, as you track the index, it may not always be easy to buy and sell some of the shares in order to keep the weighting at 2.5 percent for each share.
Index comparison
Visser compared the BettaBeta Equally Weighted Top 40 index with three other Top 40 indices:
Capped Top 40 index. No individual share in this index may have a weighting of more than 10 percent, which minimises the risk of concentration of large stocks. There are no ETFs that track the Capped Top 40 index.
Market Cap Weighted Top 40 index. This index represents the largest shares on the JSE by market cap and is tracked by the Satrix Top 40 ETF.
Shareholder Weighted Top 40 index (Swix 40). The weighting of companies in the index is reduced based on the number of shares held by foreigners. This means resources and dual-listed companies are down-weighted. This index is tracked by the Satrix Swix 40. Landman says you should choose this ETF if you want to closely replicate the core holdings of large active fund managers.
For the period from December 2002 to the end of May 2010, backward projection shows that the BettaBeta Equally Weighted Top 40 index returned 18.7 percent a year (only 0.1 percent lower than the highest return by the Swix weighted Top 40) but at a much lower risk - 19.5 percent - than the other three indices.
"The term beta is used in investment management to refer to performance attributable to general market performance, or passive investment performance, while alpha refers to active investment management. Hence the name BettaBeta," Visser says.
Landman says he believes it is inappropriate to compare the BettaBeta Equally Weighted ETF with ETFs tracking the market cap weighted Top 40 or Swix 40, as they are structurally different indices. "The BettaBeta ETF is more akin to the Rafi approach," he says.
"The Satrix Rafi is a new type of ETF that uses a well-researched international approach to acknowledge that, by not weighting stocks based on their market cap, one can seek to add some outperformance relative to a market cap index like the Top 40 or Swix," Landman says.
For the year to May 2010, the Equally Weighted Top 40 index out-performed the FTSE/JSE Top 40 index by 7.6 percentage points (a 23.1-percent return compared with a 15.5-percent return for the Top 40 index). Performance of the two indices is highly correlated and it is expected that their performance will be very similar over longer periods.
Satrix's Rafi ETF and Divi ETF delivered 26.36 percent and 33.03 percent respectively over the same one-year period.
How to invest in ETFs
You can invest in ETFs through a stockbroker or financial adviser or directly through, for example, online ETF platform etfsa (www.etfsa.co.za) or, if they are Satrix ETFs, through Satrix (www.satrix.co.za).
On all transactions you will pay an administration fee (Strate levy) of 0.005 percent of the transaction value, plus VAT. The maximum charge is R54.59. There is also an investor protection levy of 2c a transaction.
Stockbroker: If you invest through a stockbroker, you cannot invest in ETFs via a debit order. Minimum investment amounts may apply. The minimum brokerage charge will be between R85 and R125 a transaction. You also have to pay annual custodian fees of R600 to R700 and advice fees of one percent a year.
Direct investment: The minimum you can invest is a debit order of R300 a month or a lump sum of R1 000. The brokerage fee is 0.1 percent of the value of your investment. The annual administration fee is between 0.45 and 0.8 percent, depending on the amount invested. There is an initial administration fee of R3.50 per debit order.
Financial adviser: If you invest on the etfsa or Satrix platforms through a financial adviser, your adviser may charge a monthly trail fee of up to one percent of your investment a year, deducted monthly.
  
 
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