Exchange-traded funds

Exchange-traded Funds (ETFs) are among the more innovative investment products to emerge over the last two decades.

Since the launch of the first ETF in the United States in 1993, ETFs have opened a whole new vista of investment opportunities around the world as well as in the South African market.

What are ETFs?

ETFs are open-ended index funds that are listed and traded on exchanges like stocks. By considering this definition more closely, one can grasp several important characteristics of ETFs that distinguish them from other investment alternatives.

ETFs are:

index funds or index trackers – products that track economic performance of large collections of different stocks or other financial assets (e.g. bonds, commodities, etc.). These large collections are called indices (plural of index) because they are constructed in such a way to approximate the economic performance of the overall market or a market segment. For the investors it means that:

their investment is diversified – purchase of a single share gives exposure to the whole market or market segment;
index-tracking investment is done on a passive basis – a disciplined investment strategy generating market returns at generally lower costs than their active counterparts; and
investors know exactly what they are invested in – because the composition of any index is known exactly on a daily basis. An investment in an ETF is fully transparent;

exchange-traded – contrary to most other investment products popular with retail investors (e.g. unit trusts, annuities, etc.), ETFs are listed on a stock exchange, giving investors real-time access to markets, and with it more control over their investments. ETFs can be bought and sold at any time during the JSE trading hours;
open-ended – every ETF security issued and listed on an exchange is linked to a physical holding of underlying assets comprising an index tracked by the ETF. For the investors it means that:

the value of any ETF is fully backed by a physical holding of underlying assets – there is no gearing of any kind; derivatives are not used. The ETF assets are held in a trust and there is no credit risk associated with holding an ETF;
all the returns generated by those assets (interest, dividends – as the case might be, as well as the capital growth) are passed (after fees) to the investors;
ETFs can (for larger holdings) be exchanged for underlying assets and vice versa, underlying assets can be exchanged for the holding in the ETF. This ensures that the price of an ETF will always fully track the value of the index (i.e., the underlying assets); and
ETFs are very liquid (or as liquid as the underlying assets) because, similarly to unit trusts, whenever there is demand for more ETF securities, they can be created by purchasing underlying assets (and, conversely, any surplus selling of ETFs by investors can be accommodated on a similar basis). The liquidity is greatly enhanced by the (statutorily mandated) existence of a market maker, a specialised market participant that will provide necessary liquidity to all other market participants (i.e. there is always somebody on the other side of the trade).

In South Africa, most ETFs are structured as Collective Investment Schemes (CIS), which is another name for unit trust companies. A good way, therefore, to look at ETFs is as unit trusts that happen to be listed on a stock exchange. As such, ETFs combine all the benefits of a unit trust such as investor protection (since the assets are held in custody on behalf of investors), full disclosure and tax benefits, with the convenience and efficiency of trading a listed security.

ETFs are regulated and are structured in such a way as to provide full protection to the investors (i.e. they are insolvency remote, as their obligations – securities issued – are fully backed by assets generally held in a trust with independent trustees).

State of the SA ETF market

The South African ETF market offers investors a great diversity of exposures. South African investors can create a well- diversified investment portfolio using ETFs – a portfolio comprising all major asset classes in a convenient way and at costs that are in general significantly lower than those offered by the competitive investment categories. There are currently 95 ETFs that are actively trading on the Johannesburg Stock Exchange (JSE) with a combined market capitalisation in excess of R128 billion.

In September 2022 the JSE announced that the Financial Sector Conduct Authority (FSCA) approved amendments to the JSE Listings Requirements that paved the way for issuers to list and trade Actively Managed ETFs (AMETFs).

These amendments, which came into effect on 14 October 2022, were the most significant recent regulatory changes to the local Exchange Traded Funds (ETF) industry since the South African Reserve Bank (SARB) issued an Exchange Control Circular in February 2017. The changes allowed locally registered Collective Investment Scheme (CIS) management companies to list ETFs related to offshore assets on South African securities exchanges. It allowed these funds unlimited investment in offshore assets, subject to the restrictions on their offshore portfolio allowances.

AMETFs are funds that are traded on the market whereby the investment manager uses an actively managed investment strategy to produce a return for the investor rather than utilising a passive investment strategy.

Investing in ETFs

Investing in ETFs is as simple as investing in a regular share – all it takes is a call to your adviser or a click of a mouse on an online share trading site.

The information contained in this article is of a general nature and intended for information purposes only. It is neither to be construed as financial advice nor to be regarded as a definitive analysis of any financial, legal or other issue. Individuals must not rely on this information to make a financial or investment decision. Before making any decision, we recommend you consult your financial planner/adviser to take into account your particular investment objectives, financial situation and individual needs.