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ETF's are taking over the world - but are they as safe as everyone says?

by , 21 September 2017
ETF's are taking over the world - but are they as safe as everyone says?
In a recent report from ETF.com data released shows that the US have had $250 billion worth of cash inflows into ETF's during 2017 alone!

According to an estimate by The New Yorker, around 20 percent of the market in the US is made up out of JUST ETF's.

And “When you factor in “closet indexing”—when individual or institutional investors pursue indexing strategies without declaring them—the proportion of passive investors is higher still.”

In South Africa the trend has been a bit slower.

Satrix 40 sits at a R6.5 billion market cap, DBX USA on a R4.8 billion market cap and DBX World on a R4.1 billion market cap.

Whilst the ETF sector here at home isn't nearly the same scale of that in the US yet, it is growing.

More and more people are being advised to invest in ETF's for their low risk.

And with the advent of Tax Free Savings accounts it's become increasingly attractive to invest in ETF's.

I managed to outperform the JSE All-Share and every fund manager by more than double over the past six years.
And I can proudly say that, without a shadow of a doubt, the Room 305 strategy has been the biggest influence on my career – and still is to this day.
Should you invest in ETF’s at all?
I’ve advocated using ETFs to lend stability to your investment portfolio before. My personal strategy is to put half my money in my actively managed portfolio (of mostly penny stocks) and half in ETF’s. That way you get smoothed out returns because of the predictability of ETF returns.
But if there’s one thing I need to warn you about it’s that all ETFs are not equal.
In fact, there are a couple of major flaws with some ETFs that could cost you a lot of money!
The Satrix 40 ETF for instance grew only 0.4% in the past year, whilst the Satrix RAFI 40 ETF gained around 4%. Both ETF’s invest in nearly the same portfolio – they just follow a different approach…
So, how could you have been on the winning side of this investment decision?
Well, watch out for these three investment pointers before you invest in an ETF and you’ll be on the winning side.
Three ETF investment pointers you CANNOT ignore
ETF Investment Pointer #1 – All ETFs are not made equal
Let’s consider two property ETFs for a moment. These are the CoreShares PropTrax SAPY and PropTrax Ten ETFs.
Both these ETFs give you performance based on companies in the South African property sector.
The PropTrax SAPY gives you the performance of the top 20 property companies in South Africa – on a market cap weighted basis. PropTrax Ten gives you the performance of the top ten property companies, but on an equal weighting basis.
Why does this matter?
Well, with the market cap weighted basis the largest companies make up the largest portion of the index. In this case Growthpoint makes up 19.7% of the total ETF.
The three largest companies make up nearly 50% of the ETF. So, while it sounds like you get diversification with 20 shares, the truth is that three shares basically make up all the returns on this ETF. The equal weighted ETF means each of the ten shares makes up 10% of the ETF. Whilst ten shares are less, you are better diversified in that the bulk of the ETF isn’t built on any one single share.
In the same way, there are different options for the Top 40 Index, with a market cap weighted Top 40 Index, the Swix Top 40 index (which is based on the % South African shareholders of companies) and the equally weighted Top 40 index.
Always check the fund fact sheets. If you’re looking for more diversification – the equally weighted index is typically better. If you’re looking for better performance in the short run – the market cap weighted index tends to outperform.
If you’re not prepared to lose, then sports-betting
isn’t for you
One of my subscribers actually sent in an email to me at The Winning Streak saying:
“This is not for the faint hearted, but if you want to make fast money, doing very little ‘work’, there simply is no better way than The Winning Streak.”
And I couldn’t agree more.
ETF Investment Pointer #2 – Not all ‘Smart’ ETFs are all that smart…
Smart ETFs are ETFs that don’t just follow an index based on equal or market cap weightings.
They use algorithms or criteria to determine weightings of shares in the index.
Examples of these are the Satrix RAFI and Satrix DIVI ETFs.
Whilst the idea sounds attractive – you invest in an ETF that tracks the top dividend payers in the country – it isn’t always so smart.
You see, the Satrix DIVI for instance proved this some time ago. The index looks at HISTORICAL dividends. That means a company with the largest dividend in the past year will be very attractive to it – but it doesn’t consider whether that dividend will be repeated.
In 2014 African Bank was one of the largest holdings of this ETF and it lost big when African Bank stopped paying dividends. The disappointing bit is the fact that any investor knew it would happen – but the ETF stayed invested because that is its rule…
Then in 2015 it became apparent that iron ore companies wouldn’t be able to keep up their big dividend, yet Kumba Iron ore and Assore was two of the largest holdings in the index. Thanks to this, the Satrix Divi ETF sits on a 5.24% total return for the past FIVE years, compared to a 57.66% total return for the Stanlib 40 ETF over the same time period. 
These smart ETFs can give you better performance than normal market cap weighted ETFs. But they tend to be very dumb the moment something abnormal happens in the market. For that reason, rather steer clear of them, and generate your outperformance from your share portfolio. ETFs are there for stable and steady returns.
ETF Investment Pointer #3 – The same investment can cost you different fees…
At the start of ETFs your only choice was investing in SATRIX ETFs. These days there are a myriad of companies offering you ETFs.
Satrix offers a Top 40 ETF, but so does Ashburton and Stanlib. They all track the same Top 40 index, and offer you the same ETF.
But what you will notice is that these companies charge different fees.
Stanlib would’ve returned you 12.19% in the past year, Ashburton 12.03% and Satrix 12.03. So, it’s clear that Stanlib’s lower fee means around 0.16% extra performance in a year. That doesn’t sound like a lot – but it is enough to cover your brokerage costs or research subscription over the long run.
Make sure you watch out for these pointers before you invest in ETFs. They can save you a lot of money – and make you even more if you use them to pick the right ETF in the future!
Francois Joubert built his property empire using other people's money
He bought his first property when he was a broke student with less than R20,000 in the bank using this method, and he hasn't looked back since.
Today, at just 27 years old, his property portfolio is already worth over R3.585 million rand.
ETF Investment Pointer #4 – Don’t miss out on the offshore exposure!
Investing offshore is easier than ever before thanks to ETFs. You no longer need to be constrained to South African companies.
So make sure that you invest at least 25% of your ETF portfolio in offshore ETFs.
DBX Euro – an ETF tracking the top European shares – have returned 14.89% in the past year, DBX World, DBX USA and DBX Japan have returned 6.61%, 6.38% and 6.14%.
That performance compares very favourably to the South African Satrix 40 which only returned 0.4% for the past year!
In fact, on a five year basis the DBX World ETF would’ve returned you 156.56% compared to Satrix 40 at 57.73%.
Remember – ETF’s don’t need to replace your entire investment portfolio. But they have become an essential tool that you need to use if you want smoother returns and great offshore exposure.
Here’s to unleashing real value
Francois Joubert

ETF's are taking over the world - but are they as safe as everyone says?
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