ETF: Something new for investors

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27-06-2007: ETF: Something new for investors

Local investors will soon have the option to invest in a new type of instrument — Equity Exchange Traded Fund (ETF). The FBM30etf will be the first ETF, introduced by AmInvestment Bank Group, to be listed on the Bursa Malaysia next Monday.

What is an ETF?
An ETF is very similar to open-ended unit trusts. It's an instrument representing a basket of stocks that is most commonly designed to track the performance of all kinds of indices. For example, there could be an ETF to track the KLCI, the Second Board Index; a sector index, like the Property Index; or in this case, the FTSE Bursa Malaysia Large 30 Index. More innovative ETFs can track commodities like oil futures and gold.

Why invest in ETF?
ETFs, like unit trusts, offer investors the benefits of diversification. For instance, an investor buying the FBM30etf will gain exposure to the 30 largest companies by market capitalisation, all in one. In other words, they don't have to fork out a lump sum of money to buy each and every one of the 30 stocks — just the minimal one board lot (or 100 units) of the FBM30etf.

Better yet, ETFs usually has lower expense ratio than comparable unit trusts. Annual management fee for unit trusts usually range between 1% and 2%. By comparison, the annual administrative fees for FBM30etf are estimated to total around 0.65%.

The lower fees and expenses are, primarily, because ETFs are passively managed funds. That means the underlying portfolio of stocks and weightings simply mirror the indices they're tracking. In short, investors do not get the benefit of fund managers stock picking or timing the market. Having said that, it remains arguable whether actively managed funds do perform better over the longer term.

Unit trusts also have higher sales charge, typically 5% or higher, whereas the transaction costs for ETFs are similar to those for normal shares trading including brokerage commission (0.3% to 0.6%), stamp duty and clearing fees.

How to buy and sell ETFs?
Trading in ETFs is also a simpler and more convenient process — it's just like stock trading. Investors can buy or sell the ETF by calling their remisiers at any time during trading hours and using the same trading/CDS accounts. This allows investors to be more responsive to market changes. Transactions are settled in the usual way as stocks are, on T+3.

The price of an ETF is determined by demand and supply but shouldn't stray too far from the market value of its underlying portfolio. ETFs also normally have a dividend policy. The FBM30etf expects to distribute any dividends and interest income it receives semi-annually, after netting expenses.

In a nutshell...
ETFs offer investors a relatively low cost, passive way of investing in the market. Returns will more or less mirror the future performance of the underlying index. Under prevailing trading conditions, we suspect that the FBM30etf will do fairly well.

While sentiment for the broader market has been somewhat ambivalent of late, share prices for key blue chips have been inching higher. The FBM30 Index has risen some 47% since its creation just over a year ago, while cumulative gains year-to-date stand at roughly 25%.