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The year 2018 is seeing a flurry of new exchange-traded funds (ETFs) coming to market with at least three issuers listing new ETFs during February and March.
We have 63 listed ETFs (with 15 added last year) and 22 exchange-traded notes (ETNs).
The new ETF listings should add at least another 11 new ETFs, which also make the landscape more complex.
Choices, choices
This complexity occurs on two levels, the first being choice. We currently have four vanilla Top40 ETFs, three ETFs tracking the S&P500, and two on the MSCI World Index.
Now, choice is always great. We simply buy the one that is the cheapest in terms of costs (remember that the spread is also a cost).
Typically, we’ll look at the total expense ratio of an ETF and use that as the only arbitrator of cost.
But when we’re buying, we’re likely to also have to cross the spread in the market. In other words, pay the price the seller wants.
Locally, ETFs have market makers who are always in the market on the buy and sell side, adjusting their price to ensure the ETF trades at fair value.
But these market makers are actually slightly above and below the fair value. For example, two ETFs that are exactly the same may have different spreads, with one being wider than the other.
The wider one will be more expensive, say selling at 5 460c, whereas the other is selling at 5 450c.
Here the 10c difference really is very small, but it is always worth checking and if everything else is the same, this would be how I decide which to buy.
Index trackers vs Smart beta
The other complexity is when we move away from standard vanilla index-tracking ETFs and move into what the industry calls smart beta.
Smart beta is the idea that rather than just using market-cap weighted indices, you can make them a little smarter (and hence generate better returns) by using equal weight or some fundamentals to determine inclusion or weighting in the index.
Now I am a fan of equal-weighted indices and always prefer those over market-cap indices.
But when we start to venture further into smart beta I start to worry.
The Satrix Divi+ was the first smart beta in South Africa and it started off very well, but then I sold my positon, calling it a busted methodology just as it started to set the market alight with greatly improved returns.
Over the past decade it has only just beaten the Top40, although with increased volatility and a slightly higher yield.
It is important to understand the smart beta methodology when buying and to be very careful not to fall into the marketing trap.
Every ETF issuer loves their products and thinks they’re the best. But that doesn’t mean we need to buy them.
If I am considering a smart beta ETF, I want it to be very simple with a methodology that makes sense to me.
Be wary of niche offerings
I am also very cautious about really niche ETFs. We have very few locally, but I do suspect more will be coming in time.
Here I worry that these niche ETFs draw us into exciting sectors that may not stay that way in the long term.
A product or sector may be booming at the moment, but if it is not always going to be flying, then I have to actively decide when its day is over and exit the position, finding the next booming space.
Having to sell the one ETF and then buy a new one means making two major decisions, and I could get either or both wrong, which would cost me.
Choice is great, but as always, we need to think slowly and invest even slower.
There’s no rush, and in many cases I’ll rather give the new funky ETFs some time to prove themselves.
This article originally appeared in the 15 February edition of finweek. Buy and download the magazine here.
