ETFs: Fact vs Fiction

Sebastian Sieber, partner for Syfe, reached out to me at Distrii Singapore to hook up with Mun Fai Cheong on “SPDR x Syfe ETFs: Fact vs Fiction” on 14 Jan. Mun Fai by the way, is Vice-President at State Street Global Advisors, for SPDR Exchange Traded Funds (ETFs).

State Street Corporation for that matters, is responsible for 10% of the world’s assets and the third largest global manager of ETFs (approximately $715 billion in total global ETF assets). If we can’t visualise what that numbers mean, just know that it is massively HUGE.

In recent years, increasingly there is greater adoption of ETFs in investor’s profile due to its lower cost nature and accessibility. With ETFs, there is full transparency whereby you may know the exact percentage of holdings which is updated once at the end of the trading day. In short, ETFs can augment active exposures and enhance returns while lowering cost.

While ETFs is designed to be used very simply, the understanding of ETFs may not be easy however. As ETFs become more popular, more news and information becomes available, yet not all may be true. It is still important to distill the facts from the fiction.

The 6 most common fictions are as such:

FICTION #1: Fixed income ETF market has become so large it distorts the bond market

ETFs forms only a fraction of the market, whether it is by assets under management or trading volume.

FICTION #2: Fixed income ETFs are not sufficiently liquid, investors can run into trouble when many try to redeem at the same time

In comparison to index fund, actively-managed fund or even a single bond, a fixed income ETFs has considerably higher liquidity. It is minimally as liquid as the underlying market it tracks. Moreover, it can be traded off the primary and secondary markets.

FICTION #3: For a fixed income ETF, investor is overweight the most indebted — and therefore the riskiest — companies

While it is true that fixed income is an instrument of indebtedness, not all big debts necessarily mean bad debts. In fact, the ability to issue higher debts is directly related to a company’s overall financial strength.

We see big names such as JP Morgan, AT&T and Microsoft for example, having high debts, however, this is backed up by their sales, asset value and combined market equity value.

FICTION #4: Fixed income ETFs under-perform active managers during volatile markets

A comparison over 5 systemically important volatile markets from 25 years ago till date showed that 77% of active managers “lost” to index based fixed income exposure. Do we need say more?

FICTION #5: Fixed income ETFs are only useful for the largest, most straightforward bond exposures. Active managers provide a better return for niche areas, such as emerging market debt

We look at a sample niche area, a high percentage of active managers in fact under-perform the benchmark in the period of comparison from 2013 to 2018.

FICTION #6: Index investing don’t work for bonds, because there are too many bonds to index efficiently

We have to understand that for index investing, the goal is not to hold every bond in the index, but to track the return with minimal tracking error due to exposure differences.

CONCLUSION

Before investing, you have to understand the underlying instrument that you are investing in. This session has indeed leveled up my understanding of ETFs. There are many ETFs tracking the different underlying index. ETFs don’t just track the cream of the crop. There are ETFs that comprises also of big-, mid- and small cap companies.

Mun Fai Cheong (Vice-President, State Street Global Advisors) and Dhruv Arora (Founder & CEO, Syfe)

When investing in ETFs, we have to look in totality of the management fees, trading fees and tracking error etc. In this current climate, while the outlook is still on an uptrend due to the various positive factors and stimulation, it is good to have a defensive bias by keeping an eye on higher quality or defensive stocks.

Stay vested, but continue to be vigilant of the climate.

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