Significant growth in ETF and indexation market signifies notable disruption in SA

Referred to as the Ted-Talk of asset management, Meet the Managers 2021, organised by the Collaborative Exchange, offers financial advisers and asset allocators content and financial markets fund insights. Speaking at this year’s Meet the Managers, Kingsley Williams, Chief Investment Officer of Satrix – Morningstar’s 2021 Best Fund House: Larger Fund Range - presented indexing through time, a look into whether South Africa has been left behind in the global adoption of indexation.

Williams explained that in the last decade, there had been many breakthrough technologies that have re-shaped the nature of entire industries, from how we make things to how we sell them. In finance, the most notable disruption has come from the rise of the exchange-traded fund (ETF), which as an investment vehicle has grown five times in size in the last decade. He notes that in South Africa, indexation more generally has grown even faster.

But how did the ETF originate, and how has its use evolved? The first officially recognised ETF was created in 1990, tracking the Toronto 35 Index in Canada. The US followed shortly thereafter with the very well-known SPDR ETF tracking the S&P 500, and in 2000, Satrix launched the first ETF listed on the JSE called Satrix 40, which showed that indexing and ETFs could also work in much smaller and more concentrated markets like South Africa.

“Over the last 2 decades since the first ETF was listed in South Africa, it may surprise you that our ETF market has grown at a very similar rate to the U.S., where index-based funds account for the majority of fund assets under management (AUM).

While the quantum of assets is different, due to the varying market sizes, it shows that ETFs have grown as quickly in South Africa as they have in the US”, noted Williams.

Williams outlined his top five reasons for the significant growth in ETFs and indexation:

1. Evolution of portfolio construction

Being able to control portfolio construction and have more predictable outcomes within each component of your portfolio leads to more certain outcomes overall. Through indexing, it helps to keep the very active investment management process focused on the primary drivers of performance and greater certainty in the outcome.

2. Greater choice

Indexing is more efficient in providing core beta exposure or strategic factor-risk premia, which will continue to replace costlier, actively managed funds essentially offering the same thing. However, this will force active managers to offer a purer source of alpha, not easily captured through indexing. Alpha can also come from investment strategies offering exposure to themes and global trends (which can also be delivered through indexing), providing even more choice to investors to index other components of their portfolios, explains Williams.

3. Accessibility

ETF access conveniences include not needing to open an account with different providers to access their funds – a significant benefit for institutional investors who often have to go through onerous processes each time they want a new exposure or strategy in their portfolio. It also provides the accessibility of intraday trade if this is a required feature of your investment strategy. ETFs improve accessibility as they are increasingly being used as the preferred vehicle to bring new exposures or investment strategies to the market.

4. Lower return environment

Lower turnover and lower trading costs globally result in almost zero transaction costs within an ETF. Lowering the total investment charge (TIC) of your investments by using unit trusts (UTs) and ETFs is one way to ensure more of the net real return (i.e. after inflation and after fees and expenses) is available for clients.

5. Compelling performance

The graph above shows that the arithmetic of active management [1] works in practice with the distribution of rolling 3-year returns plotted relative to the CAPI after costs (0%) [2]. You can see it outperforms the median manager with a high frequency and probability and provides performance more closely aligned with top quartile performance. “It’s not that actively managed funds don’t outperform, it’s just that the odds are against you consistently picking a top-performing active fund, particularly when the consistency of performance of individual active funds is so low”, explains Williams.

Globally, investors have also realised the benefits and convenience of accessing different asset classes through the ETF mechanism thereby making other asset classes such as bonds more accessible. “Satrix also responded by bringing both local and offshore bond ETFs in addition to a wider range of international offerings to grow the range of indexed investment strategies available to South African investors”, concludes Williams.

ENDS

[1] William F. Sharpe, “The Arithmetic of Active Management”, The Financial Analysts Journal Vol. 47, No. 1, January/February 1991, pp. 7-9. [2] Performance of retail class active funds excluding fund of funds and index funds. Benchmark index less 50bps per annum. Source: Morningstar, FTSE/JSE & Satrix, January 2002 – December 2020