Exchange Traded Funds and the Retirement Industry Presentation to members of Batseta April 2018 Nerina Visser ETF Strategist & Advisor etfsa.co.za
Nerina Visser, CFA Consulting & Advisory Work World Bank / IFC Financial Services Board (FSB) Johannesburg Stock Exchange (JSE) OUTvest (Outsurance) Satrix Managers Momentum SP Reid Cloud Atlas Investing Rwanda Stock Exchange S&P Dow Jones Nigerian Stock Exchange Nedbank CIB & Private Wealth Academic & other Qualifications BSc Applied Mathematics & Mathematical Statistics MBA (Financial Management specialisation) CFA Charter holder FAIS Key Individual Training and Education Initiatives ASISA Academy: CIS Short Course ASISA Academy and University of Johannesburg: CIS@UJ Financial Services Board (FSB): Exchange Traded Products (ETPs) training workshop Passive Investment Management Mastery School (PIMMS): online course Journalist Training Academy (JTA) for FinWrite Wits Journalism Nigerian Stock Exchange (NSE): ETF Workshop Industry Volunteer Involvement CFA Society South Africa President CFA Institute Society MarComm Council member ASISA Investments Board Committee ETF Standing Committee chairperson JSE Issuer Regulation Advisory Committee member JSE Product Advisory Committee member SWIFT African Advisory Group member Collective Insight publication Editorial Advisory Committee member NSE ETF Product Advisory Committee member 2
Agenda What is index tracking, what is passive investment and what are Exchange Traded Funds (ETFs)? History of ETFs global and SA Developments in indexation Pro-active passive investment management strategies Using ETFs in Retirement Funds 3
Part I What are we talking about? 4
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Passive investment Index tracking Index tracking means following a recipe To bake a cake, your recipe specifies the ingredients and quantities 6
What is Passive Investment Management? Replicating an index investing in the same assets as index The index provider determine the portfolio in an index tracking portfolio, not the asset manager An index measures the average return of the market, or specific sub-set of the market (e.g. sector, high dividends) Index can also measure different asset classes: Equities Bonds Listed Property Commodities Currencies Cash (money market) 7
The Arithmetic Case for Passive Investment Management In any investment market, half the market participants will outperform and the rest will underperform the average market return The average market return can be measured by an index investment according to this index equates to the passive market return Before costs, the return of the average active manager will equal the return of the average passive manager 8
The Arithmetic Case for Passive Investment Management (cont.) Because active and passive returns are equal before costs, and because active managers bear greater costs, it follows that the after-cost return of the active manager must be lower than that from passive manager William Sharpe Mutual Fund Perspectives (1966) The Arithmetic of Active Management (1991) 9
% Total Return Perception of average 30 25 20 15 Index return Index tracking fund return 10 5 0-5 -10 All General Equity Funds 10
What we know to be true ±80% of active managers underperform the general equity index 11
% Total Return Reality of average 30 Index return 25 20 Index tracking fund return 15 10 5 0-5 -10 All General Equity Funds 12
Exchange Traded Fund (ETF) Defined Listed (necessarily) index-tracking (usually) collective investment scheme (sometimes) Listed: trades like any other share on the stock exchange Index-tracking: fund replicates the make up of the reference index it physically holds the shares in the index, so its liability is 100% covered Collective Investment Scheme (CIS): regulated unit trust under CISCA 13
What does an ETF represent? Open-ended investment fund backed by a basket of physical securities Offers investment exposure to different underlying assets: equity, fixed income, property, commodities via a single listed share / unit Most ETFs are registered as CISs (unit trusts) A market maker ensures that there is always a buyer and seller in the market at the live fair value (NAV) of the ETF (underlying fund) 14
ETFs are Low Risk Investments Absolute Risk An ETF carries just as much absolute risk as its underlying investments can be very high, or very low It s the same as a unit trust in the same category Relative Risk An ETF has negligible relative risk SA regulations require full physical backing The level of underperformance cost to manage the fund (TER) Regulatory Risk An ETF has the lowest regulatory risk governed by FSCA & JSE 15
Part II How did we get to where we are? 16
Global history ETFs first launched in Canada in 1990 US followed in 1993 Net flows into ETFs surpassed those of mutual funds (unit trusts) for first time in 2008 Global assets of over $1 trillion in 2009 (20 years) Currently $5 trillion Global ETP industry is now bigger than hedge fund industry Source: www.etfgi.com, Feb-18 17
AUM (ZARm) SA history 90 000 80 000 70 000 60 000 50 000 40 000 30 000 20 000 10 000 0 100 90 80 70 60 50 40 30 20 10 0 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 Commodities Equities Bonds Property Other # of ETPs (RHS) ETFs launched in SA in 2000 (Satrix40); currently 93 ETPs listed on JSE Assets of ±R82 billion; growth in new listings since 2017 National Treasury has identified ETFs as key in achieving reduction in costs and increase in transparency in their quest to reform the retirement and savings industry* 18 Source: JSE, ProfileMedia * Strengthening retirement savings National Treasury 14-May-12
Make-up of SA industry Number ETF vs. ETN Market cap (Rm) 20 R9 086 ETF ETN 73 R72 732 19 Source: JSE via ProfileMedia, etfsa calculations, as at 10-Apr-18
Make-up of SA industry Number Issuers Market cap (Rm) 1 3 14 2 23 ABSA Satrix CoreShares Ashburton R4 991 R6 508 R15 R1 838 R27 146 Stanlib 10 Firstrand Sygnia R16 198 Deutsche 3 8 5 10 14 Cloud Atlas Standard Bank Investec R1 566 R2 907 R2 252 R2 934 R15 461 20 Source: JSE via ProfileMedia, etfsa calculations, as at 10-Apr-18
Evolution of passive investment strategies Exposure to broad-based equity market indices Traditional passive investing Efficient exposure to (market) beta Benefit: low cost, transparency, operational and tax efficiency Expansion of passive to other asset classes Application of indexation beyond equities ETFs with non-equity underlyings allow for multi-asset class exposure via stock exchange Benefit : ease of transaction; security of custody, clearing, settlement 21
Make-up of SA industry Number Asset Classes Market cap (Rm) 3 R731 19 Equity Bonds R33 078 2 7 53 Property Multi-Asset Commodity Currency R44 871 9 R81 R1 218 R1 839 22 Source: JSE via ProfileMedia, etfsa calculations, as at 10-Apr-18
Smart Beta Reflect Different Sources of Investment Return The different sources of investment return can be accessed using either active or passive instruments Smart ETFs offer the passive replication (index-tracking) of active, or smart indices Highest COSTS Lowest Illustrative
Indices Reflect Different Sources of Investment Return Pure Alpha Pure Alpha Investment Return Alpha Beta Systematic Beta Broad Market Beta Strategy Beta Style Beta Regional Beta Sector Beta Country Beta e.g. Momentum, Min Volatility e.g. RAFI, Divi+ e.g. Europe, EMs, Africa e.g. RESI, INDI, Property e.g. US, Japan, China Smart indices Traditional indices
Evolution of passive investment strategies Exposure to broad-based equity market indices Traditional passive investing Efficient exposure to (market) beta Benefit: low cost, transparency, operational and tax efficiency Expansion of passive to other asset classes Application of indexation beyond equities ETFs with non-equity underlyings allow for multi-asset class exposure via stock exchange Benefit : ease of transaction; security of custody, clearing, settlement Rise of smart beta and alternative investment strategies Rules-based investment decisions, commoditisation of active decision making Index construction evolves from performance benchmarks to allocation guidelines Benefit : multi-factor performance drivers; exposure consistency & style purity 25
Examples of passive building blocks JSE-listed ETPs 93 Exchange Traded Products (ETPs) cover most major asset classes Domestic equity Traditional (size-based) Smart (factors; thematic) Domestic bonds Domestic property Global equity, bonds, property Commodities Currencies Can construct fully diversified, Reg.28-compliant, balanced fund portfolios using only ETPs 26
Active versus Passive Let s get the basics right: Active and Passive refer to investment styles, not investment instruments it s NOT about ETFs vs. unit trusts ETFs cannot be grouped together and compared on a relative basis as if they offer homogenous investment opportunities Index-tracking unit trusts / segregated portfolios are also passive and smart indices incorporate varying degrees of active decisions Active-Passive is a continuum Full Active Bottom-up stock picking Based on forecasts Highest cost Enhanced index Benchmark-cognisant Relative ±weights Average cost Full Passive Index replication No forecasts Lowest cost 27
Part III What are the benefits? 28
Let s talk costs What makes an ETF less expensive? The package deal allows for economies of scale There is only one wrapper, only one transaction Nobody is paid to make investment decisions for the fund 29
Most Underrated Benefits of ETPs Transparency Consistency 30
Benefits of Listing Introduces a second regulatory oversight makes the investment even more secure No back office required for client administration STRATE maintains the electronic share register (further costs savings in the process) Democratisation of investments only one fee class, all investors are treated the same Opportunity to develop the investment industry scope for more issuers, market makers, different style of fund managers, different analytical skill set 31
Corporate Activism Index-tracking lack of activism? Not true! Active investor can sell if he doesn t like it Passive investor has no choice, it s in his interest to engage and encourage change As index-tracking increases, activists only have to engage a handful of index investors, rather than a multitude of active investors For more information: http://knowledge.wharton.upenn.edu/article/passive-investing-increasescorporate-activism/ http://knowledge.wharton.upenn.edu/article/passive-but-powerful-how-indexfunds-exercise-their-clout/ 32
Part IV How can it be used? 33
Investment Strategies Asset managers can provide superior investment performance through 1. Asset allocation strategic asset allocation to establish a composite benchmark 2. Deviate from the benchmark by Active stock selection Sector / Factor timing or tilts tactical asset allocation 34
Pro-Active Passive Investment Strategies Passive managers use index-tracking products to provide: 1. A strategic asset allocation strategy broad-based asset class benchmark index products 2. A tactical asset allocation strategy deviate from this benchmark by Sector rotation through sector index products Factor timing or tilts through smart beta products The only exclusive value the active manager can add, is through stock selection Can they add enough value to justify the extra costs? 35
Return (% p.a.) Comparative Risk and Return Profiles of Passive and Active Strategies 18 Historical Performance of Balanced Funds - High Equity Mandate 16 14 12 10 8 6 Passively managed balanced funds Significant reduction in risk for no sacrifice in return! X: CPI+7 Actively managed balanced funds 4 2 0 0 2 4 6 8 10 12 14 16 Risk (Standard Deviation % p.a.) 36 Notes: Average performance for the 5 years to Oct-16 Source: ProfileMedia data; etfsa calculations
Using ETFs in Retirement Funds Default option: stand-alone ETF Managed Portfolio Designed to suit client mandate Ultra-low cost Replacement of an active manager option Achieve better diversification, transparency and consistency Reduce costs and risks of overall portfolio Core-satellite model Use passive balanced fund as core holding in portfolio Possible satellites: Tactical asset allocation tilts Unconstrained, high conviction active 37
Benefits of using ETFs in Retirement Funds Lower costs cap total fund costs Instant liquidity helps with portfolio adjustments and new flows Transparency daily valuations available Easy to understand especially for default options Can be integrated with other portfolio strategies A dedicated passive investment team adds value by pro-active management techniques to control risks and achieve performance objectives 38
39 Questions Discussion
Contact Details Nerina Visser, CFA ETF Strategist & Advisor Tel: +27 10 446 0376 Email: nerina@nerinavisser.com Twitter: @Nerina_Visser etfsa: nerinav@etfsa.co.za www.etfsa.co.za @etfsa 40
Disclaimer etfsa.co.za: The Exchange Traded Products (ETPs) contained herein are mainly Collective Investment Schemes in Securities (CIS) and other listed securities which are generally medium to long-term investments that contain elements of risk and can be affected by market values, interest rates, exchange rates, volatility, dividend yields and issuer credit ratings. ETPs are listed on the Johannesburg, or other Stock Exchanges, and trade at ruling prices on such Exchanges. The price of ETPs can go up as well as down and past performance is not necessarily a guide to the future. The ETPs herein are listed on the Johannesburg Stock Exchange Limited and trading in ETP securities will incur trading and settlement costs. ETF securities are traded at ruling prices and can engage in scrip lending. The information and opinions provided herein are of a general nature and do not constitute investment advice. Whilst every care has been taken, no representation, warranty or undertaking, expressed or implied, is given as to the accuracy or completeness thereof. etfsa.co.za is managed by M F Brown, who is a registered financial services provider (FSP No. 39217). M F Brown has Professional Indemnity Insurance as required by FAIS. The etfsa Investment Services Company (Pty) Ltd (FSP No 40107) provides asset management as well as financial intermediary and advice services. It uses Exchange Traded Products to construct portfolios for use in Retirement Annuity, Tax Free and Discretionary investments. It holds Professional Indemnity insurance and Fidelity Guarantee insurance as required by FAIS. All opinions and information in this document may be changed at any time without notice. Redistribution, reproduction, the resale or transmission to any third party of the contents of this document, whether by email, newsletter, internet or website, is only possible with the written permission of etfsa. etfsa.co.za, its sponsors, administrators, contributors and product providers disclaim any liability for any loss, damage, or expense that might occur from the use of or reliance on the data and services provided through this document. etfsa.co.za and etfsa The Home of Exchange Traded Funds are registered trademarks in the Republic of South Africa. 41