ETF Investing In Singapore: A Beginner’s Guide
Exchange Traded Funds (ETF) have exploded in popularity, in Singapore, in recent years. However, very few people have a clear idea of what they are, how they operate and the risks they carry in pursuit of returns.
ETF’s popularity has grown in part because of the impressive returns they accord investors compared to mutual funds and individual stocks. One of the key advantages of investing in ETFs is that they offer most of the advantages of mutual funds among others.
ETFs are perfectly suited for investors who want to invest passively without having to learn or worry about how and each stock performs. These sought of investment vehicles are thus suited for people who don’t have much knowledge to make investment decisions.
What is an ETF?
Exchange Traded Funds as they are known track indexes like the NASDAQ 100 Index, S&P 500 and Dow Jones. In Singapore, most ETFs track the Straits Times Index which is made up of 30 of the country’s biggest and best-performing companies. The companies provide a fair depiction of the country’s economy and market, given that they account for about 77% of the SGX listed companies.
STI ETFs track individual stocks in the STI index in their exact weights. For example, if the DBS Group accounts for 11% of the index, an STI ETF will allocate 11% of its funds to the stock. The same principle is applied to the remaining 29 stocks.
Unlike Mutual Funds, ETFs experience price changes throughout the day as they are bought and sold. They also come with high liquidity and lower fees for investment than other investment vehicles. Investors in ETFs are entitled to a portion of profits such as interest or dividends paid. They are also entitled to residual value should a fund be liquidated.
There are multiple types of ETFs ranging from stock ETFs, Bond ETFs to commodity ETFs. Currently, there are about 80 ETFs listed in the SGX.
How do ETFs Work
Exchange Traded Funds work like normal stocks, in that they can be bought and sold in stock exchanges. They come with a ticker symbol and an intraday price data that can be studied once the markets open
ETFs issue and redeem shares on an ongoing basis, in a process that allows their prices to be in line with that of underlying securities. The number of shares outstanding in an ETF changes on a daily basis as new shares are created and others are redeemed.
Institutional investors play a key role in ensuring the liquidity and integrity of ETFs by buying and selling to create units, which are large blocks of ETFs shares.
Types of ETFs
There are different types of exchange-traded funds that track a wide variety of underlying assets.
1. Foreign Currency ETFs
Foreign Currency ETFs are designed to help investors gain exposure to a wide variety of foreign currencies, without having to complete complex transactions. They act as simple investment vehicles for tracking foreign currencies, the same way market ETFs track an underlying index.
In addition, they provide a way for investors to invest in more than one foreign currency. The most common use of these types of ETF is for speculative betting on currencies and their spot exchange rates.
2. Sector/ Industry ETFs
These types of ETFs generally track indexes that track stock in a particular industry. They provide a way for investors to limit their exposure to a particular sector of the economy, be it tech, biotech or agriculture.
3. Commodity ETFs
Commodity exchange traded funds are somehow similar to Industry traded ETFs in that they target a certain sector of the market. When you buy a commodity ETF, you don’t purchase a commodity like Gold or silver. Instead, you buy an ETF consisting of derivative contracts that emulate the price of the underlying commodity.
4. Derivative ETFs
Derivative ETFs are a type of exchange-traded funds that do not consist of equities. These types of ETFs are made up of derivative contracts such as futures, forwards and options. However, just like other ETFs, they strive to emulate an investment product. Assets in these types of ETFs can either be individual companies or derivative products.
5. Bond ETFs
Bond ETFs are some of the most complicated types of ETFs as they track less liquid investment products. Bonds, unlike commodities and equities, are not active in secondary markets as they are usually held for maturity. However, Bond ETFs are actively traded in exchanges, unlike their underlying assets.
6. Leveraged ETFs
These are controversial exchange-traded funds, better suited for professionals and those with advanced trading strategy. They are constructed with the aim of producing leveraged daily returns on underlying assets and indexes. However, a wrong move in their trading can also result in racking up losses exponentially. Some leveraged ETFs change their leverage daily while others have monthly reset.
Reasons to Buy STI ETFs
ETFs that track the Straits Times Index (STI) provide an easy way for retail investors to achieve diversification when it comes to investing in stocks. The fact that most STI ETFs own 30 of the country’ best companies in terms of performance and market value provides an easy way of investing in diverse industries in the country.
Stocks in indices like the STI are routinely reviewed in a process that allows some stocks to be added as others are struck out. What this means is that STI ETFs ensure investors get exposure to not only the best-performing stocks but also the ones with minimal risks.
Low management costs and trading fees is another advantage that makes ETFs a good investment vehicle for gaining greater exposure in the stock market. The fact that ETFs are passively managed means they have much lower expense ratios compared to other managed funds.
Most STI ETFs command management fees of about 0.3% compared to mutual funds whose fees can go up to 1.5%.
Singapore ETFs are tax efficient in that most of their tax on capital gains is paid on sale and completely up to the investor. Investors trading large volumes at times receive in-kind redemptions which allow them to redeem shares of the stocks that an ETF tracks, thus minimising tax implications.
One of the reasons why ETFs have become extremely popular in Singapore is because they offer better transparency than other investment vehicles. Mutual funds disclose their holdings on a quarterly basis, while ETFs disclose their portfolios every single day on public and free websites.
How to Choose an ETF to Invest In
With more than 1,800 ETFs in the market, it can be extremely overwhelming to make choice on the best ETF, to invest in. So what should one look at, before investing in an ETF?
1. Underlying Benchmark
While assets under management, expense ratio, and issuer do matter, the most important thing to look at, when analyzing an ETF is the underlying index. The underlying index paints a clear picture of the holdings and sectors that an ETF has invested heavily in.
While paying attention to stocks and bonds that an ETF holds is important, it is also crucial to have an idea of how they are weighted as the same goes a long way in affecting their performance. Some indexes, weigh holdings equally, while others let one or two stocks carry the burden of the entire ETF.
2. Tracking Difference
Once the underlying benchmark has been sorted out, it is important to ensure that the ETF of choice is reasonably priced, run and it is tradable. The performance of an ETF should be somehow close to the performance of the underlying index that it tracks.
For example, if the underlying index is up by 11%, the ETF, on the other hand, should be up by about 10%, taking into consideration the fact that annual fees can affect returns. A lower tracking difference, especially on the downside, goes a long way in ensuring an investor generates significant returns in case the underlying index outperforms.
3. How liquid is the etf
A fund liquidity is of utmost importance as it dictates the amount of money one is to pay in the form of ask/ bid spread. Exchange traded funds with high liquidity tend to trade with tighter spreads than funds with low liquidity. This goes a long way in reducing the amount of money one ends up paying as costs on opening a position.
However, funds with limited trading volume can also trade with tight spreads if their underlying assets are liquid. This is because the liquidity of an ETF stems from the fund itself and that of the underlying shares.
4. Expenses
Expenses in ETFs account for the amount of money that a fund charges to do its job. ETFs efficiency is analyzed by weighing the fee rate that a fund charges against how well it tracks a particular index. Exchange traded funds that charge low fees while tracking indexes tightly are usually the best when it comes to returns.
Risks of ETF Investment
1. Trading Risk
The fact that ETFs can be bought and sold like stocks presents a baggage of risks, which if not taken into considerations can drain away one’s capital. ETFs most of the time change people from being investors to active traders which can expose one to the risks of regular trading.
Regular trading can exponentially increase costs to a portfolio thus eliminate the benefit of low fees. Chances of making mistakes also increases with regular trading which could lead to a lot of losses.
2. Opening and Closing Position Risks
Finally, there are ETFs that come with high liquidity risk. ETFs that don’t have a large asset base or high trading volume can expose one to large bid-ask spreads. ETFs with low trading volumes most of the time come with a wide bid-ask spread that is not cost-effective. What this means is that the ability to close positions can be difficult, given that one must first cover the spreads to be able to break even or generate a profit.
Not being able to get out of a position in a timely fashion can lead to losses due to pricing inefficiencies.
3. Tax Risk
While tax efficiency is one of the most touted benefits of ETFs, it can also be one of the biggest risks in some ETFs. Different ETFs come with different tax synergies. Not understanding the tax implications of ETFs can lead to bigger than expected tax bill.
4. Shutdown Risk
Each year more than 100 ETFs close shop because of poor performance. While a shutdown is usually not the end of the road for investors, often times, the shutdown process can result in unexpected costs being passed to investors. Transaction costs, legal costs are some of the costs that can be deducted from investor’s capital pending the shutdown of an ETF fund.
Singapore’s Top Performing ETFs
SPDR Straits Times Index
SPDR ETF is one of the highly rated ETF in the country tracking the top 30 blue chip companies such as Singtel, UOB and DBS. With a compound annual growth rate of about 8%, it is one of the best performing ETFs providing investors an opportunity to bet on Singapore’s future growth via solid corporations.
ABF Singapore Bond Index Fund
ABF ETF is one of the biggest and earliest ETF to be listed on the Singapore Stock Exchange. Over the years, it has been growing at a strong and steady pace making it one of the most successful in the space. As of mid-last year, it had asset under management of S$869 million
Over the past 12 years, it has gained about 36% or 2.7% per year. The stellar performance is supported by low cost and reduced risk.
Nikko AM Singapore STI ETF
Nikko AM STI ETF tries to replicate the Strait Times Index that tracks the top ranking companies in the country. The ETF provides investors especially those new into the game an opportunity to bet on familiar blue-chip companies with a sense of security.
(By Neha Gupta)
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