Similar to the uptick in cross-border flows following the lifting of the Coronavirus lockdowns in late 2020 and early 2021, the surge at the beginning of this year made for a record 2-decade high. The market for ETFs has exploded in recent years as institutional and retail investors seek to diversify their portfolios while keeping costs in check.
In South Africa, the range of ETFs available to investors continues to grow and this growth is expected to continue against a background of easing regulations. In September 2022, the Johannesburg Stock Exchange announced that the Financial Sector Conduct Authority had cleared the way for actively managed ETFs to be listed in South Africa.
ETFs are an efficient wrapper that can make a wide range of investments easily accessible to all types of investors, which is why the rise of ETFs has been described as the “democratisation of investing". This news on the listing of active ETFs on the JSE was a notable milestone for the local ETF industry.
ETF Use Case 1: The Multi-Asset Strategist
When constructing a portfolio with financial goals in mind, the first place to start is asset allocation – deciding how much to allocate towards different types of assets.
In this case, ETFs focused specifically on the individual exposures can be used as building blocks to create a bespoke portfolio. These products offer a simple, efficient and cost-effective way to gain exposure to entire asset classes, sectors, themes or regions.
For example, an investor may choose to have a core exposure to South African equities, while boosting yield income by adding South African property and bonds as satellite investments. They can then enhance diversification by including satellite investments into global equities, global property and global bonds. This example is illustrated below, however there are many more possible iterations. For example, an investor may want to have meaningful allocations towards Asian equities, the US tech sector, or a theme such as electric vehicles.
ETFs are generally liquid funds, which means that multi-asset strategists can tilt their portfolios to express tactical views cheaply and easily. Broad market exposures can also be upweighted or replaced by sector specific views and/or thematic ETFs as needed.
ETF Use Case 2: Core-Satellite, Passive ETF in the Core
Another common approach to using passive ETFs in a portfolio is the core-satellite model. By using ETFs in the core of their portfolio, an investor instantly achieves low-cost, broad-market exposure and diversification. This is a cost-effective and simple way to accurately implement asset allocation decisions, while avoiding any style drift that might creep in when using an active manager.
Once the core investment – or building block – is in place, the investor may seek outperformance by adding satellite investments – for example, high-conviction stock picks, or even actively managed funds.
Under this approach, the investor blends both active (stock picking) and passive investment strategies (ETFs) to build a lower-cost portfolio that can deliver outperformance (alpha) relative to pure market returns.
ETF Use Case 3: Core-Satellite, Passive ETF in the Satellite
By contrast, many portfolio managers find themselves managing a long-term basket of high-conviction stock picks for an investor but, for a variety of reasons, the portfolio may not be entirely suitable for current market conditions, or the immediate needs of the investor. In these situations, ETFs form handy satellite investments built around the long-term share portfolio in the core to tweak the portfolio for the desired purpose.
For example, an investor might require a higher yield than currently offered by the long-term share portfolio. In this case, the portfolio manager could add higher yielding asset classes, such as bonds or property ETFs. Alternatively, the portfolio manager might have a high conviction tactical market view on a particular asset class, sector or theme, which can easily be accessed via an ETF and added to the portfolio as a satellite investment.
More ETF Use Cases
In addition to forming long-term holdings in the core, the satellite, or as building blocks in a multi-asset global strategy (as seen in the use cases 1-3 above), ETFs can be used very effectively as portfolio management tools for other purposes, such as tactical tilting, transition management, or for immediate or short-term access to a theme or geography while completing the research to make high conviction single stock or active manager selections.
In summary, ETFs are used by a wide variety of investors in many different ways. Research shows that investors who start to use ETFs will, in almost all cases, go on to use them more extensively, in larger size and in more ways than one. They are efficient, cost effective tools that ‘do what they say on the tin’ and we will continue to see widespread adoption in South Africa, as we have globally.
The content herein is provided as general information. It is not intended as nor does it constitute financial, tax, legal, investment, or other advice. 10X Investments (Pty) Ltd is an authorised FSP (number 28250). 10X Investments acquired CoreShares Holdings (Pty) Ltd (“CoreShares”), the holding company of a leading independent passive manager, CoreShares Index Tracker (RF) (Pty) Ltd specialising in index-tracking investment solutions across Exchange Traded Funds (ETFs), Unit Trusts and segregated mandates (for institutions). The acquisition of CoreShares forms a key part of the strategy reset at 10X.
