Thursday, September 12, 2013

My ETF Gripes

Don't get me wrong, I love all the pros about ETFs. Passive investing statistically is proven to beat most managers over the long run. I don't doubt that assertion, and I would be rather content with getting the returns of the index. I don't have the urge to outperfom, because that is where all the risks are located at as well. Following the advice of Graham, I am really rather satisfied to just get average returns.

So, with all the proponents of ETFs out there, I'd thought I'd share why in my case, it is better for me not to go with ETFs.

Firstly, the ETF universe in Singapore is rather small and limited. The ETFs that we have listed on SGX is a pretty common face. Countries and regions, some bonds here and there. Since we are in Asia, the ETFs pretty much just sits still, unless it tracks something regionally. There is a lack of diversity and choices, and this really impedes construction. I think one of the main types of ETFs lacking are distributing ETFs. Almost all of them are capitalizing. Not that it's bad, but I think it would be nice if people had a choice between having their dividends reinvested, or being able to accumulate and plow them into other idea.

Secondly, currency risk. I mentioned this earlier in my last post. Honestly, tons of currencies are losing out to the SGD dollar. Maybe it's our fault that it is strong, but the case still stands. Many of the main currencies out there, USD, EUR, GBP, JPY, AUD have really gotten a beating. Over the long run, the currency loss would be so large, it would really defeat the purpose of investing overseas, unless there was really a lack of yield. I have recently been researching into overseas exchanges, and the LSE and DB (Frankfurt) has really caught my eye with their range of ETFs listed. However, like I also mentioned in the previous post, I have really lost faith in their currency to survive in the long run. Both areas seem to me like the only way out of their debt is hyperinflation. So then, what seems like a good bet? My research has shown that they are they Norwegian NKR, the Chilean Peso and the New Zealand NZD. Sadly to say, they don't really have suitable investable stock exchanges, so I went and looked further. I'm glad to report that I have found the Swiss CHF to seem to be on reasonable standing! So, currently as of now, I am anticipating opening up an account with SCB to be able to trade in CHF on the Swiss SIX! However, I will really wait and see. This would definitely be an avenue to explore, especially if I am unable to truly find a mix of assets to suit my portfolio needs in Singapore.

Thirdly, liquidity risk. The SGX is actually pretty good in terms of the bid-ask spread that market makers are providing. It really is quite competitive, especially the ETFs by DB. Their bid-ask spread gets as low as 0.2% and averages about 0.6% I think! That is really great. Comparing to DB or SIX, the spread is really quite competitive. However, there is a problem that I need more elaboration on. The MM offer a bid / ask price, accompanied of course with the volume at which they are willing to sell / buy. The volume for some of the ETFs are quite large, which is great, especially if I'm considering shifting from 1 asset to another asset. However, for some of the ETFs, the volume is barely enough for 1 person to make an optimum trade, or sometimes not even enough for an optimized full trade! Honestly, I really don't know how it works, perhaps the MM will see the shortfall in the volume and fill the offer, but perhaps they won't, and the latter is what scares me. I would really feel much safer if they had larger volumes to boot, but I also understand why they don't.

Lastly, the capital outlay. For ETFs to be optimally purchased, the bid-ask spread has to be low as well as the trading commission. For some of the ETFs like Lyxor, the bid-ask spread is in the region of 1.4%? Along with the commission, which if the optimal number is bought, will add in at least 0.28%, upwards to 0.6% if on the DB and not on LSE or SGX. So with the cheapest shares coming in at a 0.5% haircut off purchases over SGD9k, I find it really hard to stick that much money into 1 particular asset. And mind you, this can go up to as high as probably 1.5% on some of the more illiquid ETFs as the MMs charge more.

The capital outlay seriously prevents investors from makes more accurate and fine-tuned purchases to construct their portfolio, and more importantly, rebalancing! SGX announced that they want to drop the lots for shares. Honestly, that doesn't do anything, unless its accompanied by a drop in commission charges.

Of course compared to funds, you can get anything between 0% sales charge to 0.75% on POEMs. The initial starting capital for most funds is just a meager $1000. However, natural to funds, they have higher TER because they are actively managed. However, there are a spattering of funds with tiny expenses, even smaller than ETFs on SGX. Of course, most of them are more expensive, with some almost double the TER. The largest that I've actually considered is sporting a TER of 2.05%. That's a real drag on returns, unless they really are superbly, consistent benchmark outperformers, I'm really not going to seriously consider anything over the (personally perceived) average of 1.8%, which is already in the high range.

 Well, anywhere, there you go. To sum up, I hope you've enjoyed this disgusting wall of text, my essay on why ETFs is just not feasible for the starting out investor. That is unless you're fine with the:

1) limited options (put your secondary school permutations and combinations to good use!

2) currency risks

3) liquidity risks (okay, maybe this isn't really an issue, but I do think it could be better)

4) huge outlay of capital, or paying large commission charges (it's either one or the other!)

With that said, I am not going to abandon how I would use ETFs as an investment vehicle. Like I said, I really like the idea of passive index investing. Perhaps when my available investment capital grows much larger, and I already have in place a pretty rudimentary portfolio, that I can look towards ETFs as a serious permanent mainstay in my portfolio.

But now when capital in limited and the markets are crazy, I think I'd stick to funds for now.

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