The benefits of investing in ETFs

In recent years, the world has witnessed a dramatic change in the financial markets, which have become increasingly complex.

Many dynamic investment instruments have been created to meet the diverse needs of the investors. One of the more innovative instruments which has become increasingly popular is the Exchange Traded Fund (ETF).

To date, there are three ETFs listed on Bursa Malaysia, namely ABF Malaysia Bond Index Fund, FBM30etf and MyETF Dow Jones Islamic Market Malaysia Titans 25. The first two ETFs are managed by AmInvestment Bank Group. Datin Maznah Mahbob, chief executive officer (CEO), Funds Management Division of AmInvestment Bank Group explains what ETFs are and the benefits of investing in them.

Question: As the pioneer fund manager who developed the first bond and the first equity exchange-traded funds in Malaysia, can you explain what an ETF actually is?

Answer: An ETF is a unit trust that is listed and traded on a stock exchange. An open-ended fund with no expiry date, it usually tracks or replicates the performance of a benchmark index. This means that ETF investors hold units of a fund that invests in a number of securities.

By investing in ETFs, investors enjoy a cheaper and easier way to gain exposure to a basket of securities represented in an index through a single transaction. The basket of securities could consist of either stocks, bonds, commodities or other instuments.

Investors can buy or sell units of the ETFs on the stock exchange through any remisier, just like how they buy or sell stocks. They are required to have a Central Depository System (CDS) account and a trading account - that they use for trading stocks - to trade ETFs. In Malaysia, a single trading lot for ETF consists of 100 units. This means investors can buy or sell a minimum of 100 units for each lot.

Q: How do ETFs track an index?

A: As ETFs are index-tracking funds, it is important to know what an index is and how ETFs track an index. An index is a "basket" or portfolio consisting of either stocks, bonds or other securities which are grouped to reflect the movement of an entire market. The securities that form an index are called index constituents.

The underlying securities of the index are chosen by the Index Provider to represent the broad market or sector. For example, Standard & Poor's is the Index Provider for the S&P 500 stock market index, which comprises 500 stocks with the largest market capitalisations in the US.

An ETF tracks an index by holding securities in the same composition as the underlying index. The fund could also hold a sample of securities that statistically tracks the index closely. This means the ETF could invest in a fewer number of securities as compared to the index.

The objective of ETFs is to give returns that are very similar to the performance of the index that the funds track. The funds do not seek to outperform or underperform the index. For instance, if the index increases by 10 per cent, the price of the ETF is likely to have an increase of 10 per cent.

Q: Why should investors invest in ETFs?

A: There are four main reasons why ETFs can be a viable investment tool for investors. Firstly, it is easy for investors to buy and sell the funds. Just like trading stocks, investors could buy or sell ETFs through their remisier during trading hours or via online trading. They could check the price of ETFs throughout trading hours and enjoy the flexibility and price transparency when they trade ETFs.

In Malaysia, the prices are available real-time (live) throughout the trading day on Bursa Malaysia's MASA* feed. (*MASA refers to "Maklumat Saham", a computerised display of real-time price).

Secondly, the transaction costs of ETFs are generally lower than those of unit trusts. ETF investors do not need to pay any entry fee. They also pay lower management fees because the funds are passively-managed funds. The annual management fees for ETFs are generally below 1 per cent. For example, the annual management fee for ABF Malaysia Bond Index Fund is 0.10 per cent of net asset value (NAV) of the fund and FBM30etf has an annual management fee of 0.50 per cent of the NAV of the fund.

Thirdly, investors can diversify their investments because ETFs invest in a basket of securities rather than a single security. Hence, investing in ETFs allows them to have instant diversification in the index portfolio. Investors can also gain access to markets that are not easily available such as emerging markets by investing in ETFs that concentrate on emerging markets.

Last but not least, it is convenient to invest in ETFs because investors get immediate exposure to the underlying securities representing an asset class in an index by just making a single transaction. For instance, if investors invest in FBM30etf, they are exposed to 30 largest listed companies (based on market capitalisation) in Malaysia through a single transaction.

Usually, it is more expensive for them to buy a large number of individual stocks to track the index, and to spend on the trading costs for each transaction. When investors buy or sell ETFs, they incur transaction costs including brokerage fee, clearing fee and stamp duty which are applicable when trading stocks on the exchange.

This article was contributed by the Funds Management Division of AmInvestment Bank Group.