5min read
PREVIOUS ARTICLE Investing in a toppy market NEXT ARTICLE How to pick recession-proof stocks

Now and then as an investment writer you come across products you think should be leapt upon by investors. Products that make sense, are cheap and easy to use. Index exchange traded funds (ETFs) are one such product. I wrote about them back in 2001 when State Street first launched its StreetTracks ETFs over the ASX/S&P 50 (SFY), the ASX/S&P 200 (STW) and the ASX/S&P 200 LPT (SLF) indices. Around the same time broking house Salomon Smith Barney launched its IndexShares 100 over the S&P/ASX 100 Index, and Barclays Global Investors announced the launch of its iShares.

Five years down the track in 2006, the only ones left holding the ETF fort were State Street with its StreetTracks (renamed SPDRs in May this year to bring them in line with its global ETFs); SSB’s IndexShares had disappeared and BGI’s plans never came to fruition. There were days when StreetTracks barely traded on the exchange.

It just didn’t make sense. ETFs are cheap – SFY and STW have a management fee of less than 0.3% (compared to 1.84% for the average retail Australian share fund), and SLF costs 0.4%; they are quick and easy to buy and sell via the stock exchange, and they are transparent: they track the index pretty much exactly and you can see exactly what stocks you are holding. Moreover, unlike managed funds, which are constantly trading stocks and realising capital gains you have to pay tax on even if you don’t benefit, with ETFs you only ever pay tax on your dividends and when you come to sell.

Meanwhile in the US, Europe and the UK ETFs have been booming, with more than 1000 ETFs globally and total funds under management up at around $650 billion. In the US and the UK investors can buy and sell ETFs that track the index of everything from China A shares to municipal bonds to the gold index to Nasdaq stocks. Even Canadian investors have hundreds of ETFs to choose from.

However this may be the turnaround year for ETFs in Australia. State Street says its SPDRs are steadily gaining support, with market capitalisation across the three ETFs doubling to $900 million since early last year. Susan Darroch, head of structured products at State Street says self managed super funds (SMSFs) are driving a huge growth in demand. “People are starting to recognise what a great product this is for creating a low cost core to their portfolio that tracks the benchmark, and which you can then put active bets around.”

Now Barclays Global Investors (BGI) is back in the game with eight new iShares ETFs tracking global, regional and country indices. There is an iShare tracking the top 100 global companies (IOO), one tracking the MSCI EAFE (European, Australasian, and Far Eastern markets) index (IVE), the MSCI’s Japan Index (IJP) and the MSCI Emerging Markets Index (IEM). There’s an iShare over the S&P Europe 350 Index (IEU), over the US S&P 500 (IVV), the MidCap 400 (IJH) and the SmallCap 600 (IJR) indices.

iShares trade like a normal share on the ASX, but rather than moving up or down according to demand their price closely tracks that of the basket underlying securities in the index. That means you don’t end up with the ETFs trading at a discount to their net asset value (NAV) as often happens with LICs (listed investment companies). You’ll always have a buyer even if there is a low trading volume on the actual iShares, and you can always sell your ETFs at the price of the underlying index.

And like SPDRs they’re cheap. The iShares Global 100 Index Fund costs just 0.4%, compared to an average of 1.87% for an actively managed international share fund. The Emerging Market fund costs 0.75% compared to around 2% for an actively managed emerging markets fund.

For investors interested in diversifying into global markets, iShares are a godsend. You can use them to diversify across the entire global market by buying the Global 100 iShare, or for tactical asset allocation – moving in and out of particular global markets quickly and easily. You can focus on the European sharemaket, or take a punt on the increasingly compelling emerging markets story. Tim Bradbury the co-head at iShares says the ETFs work well for ‘core and satellite’ construction too. The iShare gives you a diversified exposure to a market, and you take specialised bets on particular international shares. You can take out a margin loan against the ETFs through most of the major lenders. (Warning: They are unhedged – so you are exposed to movements in the relevant currencies.)

The eight new iShares are great news for Australian investors but we’re still a long way off from the US, where there are around 125 iShares to choose from. Bradbury says BGI has more iShares here in the pipeline, with plans for another 10 to 12 ETFs giving exposure to Asia, global property, global small caps, energy companies, and BRICs.

BGI is also talking to brokers and investment bankers about stgeloping instalment warrants, capital protected products, and currency hedged products based on the iShares. Bradbury would also like to see the facility to short sell iShares, giving traders the ability to hedge their positions on particular shares or sectors against falls in the wider market.

But the launch of such products will be a matter of responding to demand from investors, he says. Hopefully it won’t take another five years before Australian investors are able to look past the expensive glamour of managed funds to grasp the low-cost simplicity of ETFs.

17/11/07 – GLOBAL ETFs UPDATE

Barclay Global Investors has listed a further six global ETFs, giving access to US small cap stocks and to Asian markets including China, Taiwan and South Korea.

The six new iShares are:

iShares FTSE/iShares FTSE/Xinhua China 25 (IZZ)
iShares MSCI Hong Kong (IHK)
iShares MSCI South Korea (IKO)
iShares MSCI Singapore (ISG)
iShares MSCI Taiwan (ITW)
iShares Russell 2000 (IRU)