ETF investment strategies

AN INCREASING number of investors are using exchange traded funds (ETFs) to construct or to fill up gaps in an investment portfolio. Although relatively new in the local market, the first ETF on Bursa Malaysia was listed in 2005; many investors appreciated the relatively straightforward structure of an ETF and understood what they were acquiring.

ETFs are cheaper to trade, as liquid as stocks but with diversification advantages of an index unit trust fund investors, with an outlook, can form their expectations of return as components held within the ETF are published on its website. Being passively-managed funds designed to mirror an index, ETFs do levy sales charges and have a much lower expense ratio than traditional unit trust funds. An ETF portfolio is liquid and flexible as units can be acquired or disposed of in one trade.

A recent revision to guidelines on ETFs by the Securities Commission paves the way for foreign ETFs to be cross-listed on the local stock exchange. This allows ETF issuers or fund management companies to cross-list a foreign ETF on Bursa Malaysia if it is from a recognised jurisdiction, as listed in the guidelines, or from non-recognised jurisdiction with a regulatory regime that is comparable to Malaysia. Foreign ETFs trading on Bursa Malaysia will enable investors to invest in offshore markets quickly and at a low cost. Here are two investment strategies that can be implemented with ETFs.

ETFs AS PRIMARY INVESTMENTS

A buy and hold strategy is typically recommended for the bulk of an investor's capital while the remainder can be used for tactical strategies or riskier investing vehicles such as options or derivatives. The "Buy and Hold" approach is usually done with an ETF that mirrors the broad market or holds large-value stocks.

FTSE Bursa Malaysia Large 30 Index Fund (FMB30etf) and MyETF DowJones Islamic Market Malaysia Titans 25 (MYETF-DJIM25) are local equity ETFs that provide investors with an instantly diversified portfolio. Both these ETFs hold stakes in the country's largest listed companies with MYETF-DJIM25 being syariah compliant. Investors with cross-border trading facilities can consider ETFs listed outside the country. For example, FTSE ASEAN 40, managed by CIMB Principal Asset Management (S) Pte Ltd, is a Singaporean-based equity ETF, which holds the 40 largest companies by market capitalisation across Indonesia, Malaysia, the Philippines, Singapore and Thailand.

Investors would find it fairly easy to rebalance an ETF portfolio as units can be acquired or disposed off in one transaction. This allows the weight of different asset classes to be altered when necessary, without multiple individual trades. For example, investors that need to increase their fixed income exposure can obtain units in ABF Malaysia Bond Index Fund (ABFMY1), an ETF which holds a basket of local government bonds, in a single transaction.

ETFs TO FILL UP GAPS

The advent of sector-based ETFs allows investors to tilt their portfolio towards specific sectors or industries. Moving in and out of a sector depending on analysis and outlook is known as a sector rotation strategy. The basic premise behind this strategy is that certain sectors are cyclical in nature and thus, predictable. For example, investors that expect commodities to do well once the global economy recovers can add an ETF which mirrors a commodity index or ETFs that hold the physical commodity.

Prior to sector-based ETFs, the high cost involved in this strategy limited its use to institutional investors. Retail investors have the option of acquiring sector specific unit trust funds, if available. Once available in the local market, sector-based ETFs will enable discerning retail investors to implement this strategy and profit if their outlook proves to be true.

KNOW THE ETF

There is a plethora of ETFs trading on foreign stock markets and this can occur in Malaysia when more issuers enter the local market. Investors must scrutinise and understand the difference between each ETF. For example, constituents of equity ETF can be solely large-cap companies or small-cap companies, real estate investment trusts (REITs) or commodities stock. Likewise, a bond ETF can hold government securities or commercial papers. It is essential that investors understand the holdings of an ETF before deciding on the applicable strategy.


MONITORING A PORTFOLIO

It is good practice to monitor and rebalance an investment portfolio at least once a year. Investors with ETFs in their portfolio can compare each ETF's performance to that of its benchmark index. The difference, if any, is often negligible and known as the tracking error. Tracking error occurs when an ETF's underlying index constituents are illiquid or when it does not perfectly replicate an index due to practicality or limit constraints. Investors should rebalance their portfolios if it no longer adheres to their original asset allocation, perhaps due to market fluctuations. This may require ETF units to be acquired or disposed of. Avoid making unnecessary transactions as each trade incurs a cost. Also reassess your portfolio's asset allocation, if circumstances have changed in your life, but maintain a long-term perspective.

Business Times