Friday, July 13, 2012

Concerns Over ETFs


Dear Investor Juan,

I've been reading your blog for the past 2 weeks and boy it's addicting! You got very serious talent in simplifying perplexing financial matters :)

Further to my inquiry, assuming a decent savings amount have been set aside, is it good to start investing in ETFs rather than UITFs/MFs? My colleague argues that ETFs are better than UITF/MF as investors tend to loose a lot from fees on the latter; which I agree to some extent. However, since ETF is yet to break into PH market, I can't help but be wary. I really hope they'll soon open ETF for local investors so we can finally test the waters.


Dear Haezel,

First, I would like to thank you for patronizing the blog; I'm glad to hear that you find the posts helpful. :)

I understand how there could be much concern over ETFs because they are new, but as I mentioned in this post, in essence they're pretty much the same as run-of-the-mill UITFs and mutual funds. And in choosing between ETFs, UITFs, and MFs (of the same type), arguably the most important criteria to consider is cost--that is, choose the one with the lowest total fees. In general, ETFs, particularly those which simply track indices like the PSEi, would have lower fees than comparable UITFs and MFs since there would be no need to pay a financial or investment manager (the fund would just be invested in securities that comprise the index it follows). Also, since you can sell your ETF any time, "early redemption" fees don't apply.

One thing that must be made clear, however, is that while the term "ETF" is usually associated with index funds, in theory financial institutions may also offer ETFs that invest in commodities and currencies or even an actively-managed portfolio of securities; such ETFs could have relatively higher fees, so always read the fine print before you invest.

Finally, one distinguishing characteristic of an ETF over other similar instruments is that since its price is determined by supply and demand, it could trade at a significant premium over the index that it is tracking, such as if there is very high interest in the product. In the image above, we see how the Tracker Fund of Hong Kong (orange) has deviated from the Hang Seng Index (green) which it is tracking since sometime in 2009. If an ETF is priced priced significantly higher than the index, then it may be best to avoid buying the product (and sell if you have it).

If and when ETFs are finally sold in the Philippines, two things may happen: either investors will shun offerings because of lack of understanding, or be curious enough to embrace them. While each scenario may have its disadvantages, I'm rooting for the latter to happen. We are way behind the rest of the world when it comes to financial innovation, either due to conservatism or simple incompetence (or maybe a combination of both), and ETFs are a step moving forward. Done right, ETFs should be able to provide Filipinos investors, both in the Philippines and those living abroad, with a cost-effective and manageable way to participate in the growth of the country.

Related Posts Plugin for WordPress, Blogger...