Tuesday, May 26, 2009

Analysing ETFs

It came as a pleasant surprise how SGX had expanded its portfolio of ETFs to 30 from a pathetic 10 when I was looking at it a couple of years ago. Recently, the biggest distributor Lyxor (Soc Gen), announced a further 5 ETFs to be listed. Looking at this trend, one can expect the no. of ETFs to go to 50 in the next 1-2 years, providing retail investors an inexpensive way to diversify and invest globally.

This link provides a lot of info on the ETFs listed on SGX

At this juncture, I thought it would be good to post something about this investment product which might be one of the most important factor to help one achieve a 8%pa long term rate of return. Here are a few things I thought one should look at.

1. Expense ratio
Needless to say, this is probably the first thing to check. SGX listed ETFs have expense ratios ranging from 0.4-0.9%, which is kind of expensive compared to those in the US (as low as 0.2%) but much cheaper than unit trusts at 1.5% sales charge and 1% management fee. Well Singaporeans always get short-changed, so just live with it.

2. Market maker
Some ETFs listed way back in 2001-2002 has zero trades for the past 8 years without market makers which I think resulted in their failure. Now it's impossible to buy or sell them as there are no buyers or sellers! Even though its a listed product. Then came Lyxor with its market maker (basically some execution party and ensures you can buy or sell the ETF even when there is no counterparty) and viola, ETFs took off and Lyxor now has 50% market share of all ETFs listed in Singapore.

3. Spread
Even though there is a market maker and trades get executed, some times we need to pay attention to the spread. My rule of thumb is that if the spread is more than 1%, then it's a huge transaction cost. It is not something that you can change though. My greatest concern would be that if I hold this ETF for 10 years or more when the whole world has lost interest in it, will the spread balloon? Meaning I can't sell it. I have no answer at this point. Enlightened parties, pls share!

4. Dividends
Some ETFs listed on SGX give dividends, some don't. Personally I prefer dividends, a bird in hand man! Yes academics argue it doesn't matter, it might even be better bcos the dividends get re-invested - you don't get taxed, you get higher compounded return! I don't care, I want income stream and I want it now! Well that's me though.

5. Market Cap
The size of the ETFs determine if its likely that this product will continue to be listed, and I would say go for stuff with like USD 50-100mn in size. If it's too small, there might be a chance that the distributor will delist it. Then it's trouble trouble.

6. Valuations
This would be the single most important factor determining what or when to buy. As with stocks having their PER, PBR etc. ETFs also have their PER and PBR. It is not easy to get those figures (without a Bloomberg) but I think you can try to call their hotline and ask around. My general rule of thumb would be buy at PER 12x and PBR 1.2x. Some ETFs were at this attractive level earlier this year, now they are closer to PER 15x and PBR 1.5x. So wait for them to come down.

7. Components
Ultimately, ETFs are made up of stocks. So it pays to look at what's inside and see if you are comfortable with it. As with most indices, the bulk is actually finance stocks. Like STI is 40% banks maybe 20% Real Estate stocks. Russia used to be the hottest thing in town bcos it was mostly just oil companies. Since what we want is diversification, I would suggest look for ETFs that are more balanced, or buy a few to balance it out yourself.

8. Prospectus
Lastly check out the ETF's prospectus, see if anything is amiss or if there is something bothering you? Give them a call if need be. Usually it's some salesperson that is trained to answer some standard questions but no harm trying and hope they managed to help.

I am also still learning about all these, so knowledable parties pls share what you have learnt. 2009 and 2010 would be a good time to finally put money to work and earn a decent rate of return!