Minimum disclosure documents (MDDs)* are designed to help us understand what’s inside a fund. Since their publication is a legal requirement under the Collective Investment Schemes Control Act, ETF issuers publish one for each fund at least once a quarter.
When you first look at an MDD, it might seem like gibberish. With this series of articles, we hope to help you make sense of what you’re seeing. Last week we helped you understand the objective. This week we’ll delve into the fund information. Next week we’ll look at the Top 10 holdings and sector exposure.
Reading fund information
Each fact sheet contains information about the fund. Some ETF issuers call this “portfolio details” instead of “fund information” for no good reason. There’s a wealth of useful stuff here if you know how to root it out among the less-than-pertinent information.
- Fund classification
Your first port of call is the fund classification. This is going to tell you what type of asset you’re invested in and where in the world that asset lives. Remember, an asset is something you own that can earn you money. In the ETF space, the assets are:
- Local equity (equity is another word for shares)
- Global equity
- Local real estate
- Global real estate
- Local bonds
- Foreign bonds
- Money Market funds
“South African – Equity – Large Cap” means you are investing in big shares in South Africa. “Global – Real Estate – General” means you’re investing in property across the world.
This is what you want to look at to see if you’re sticking to your investment strategy. Let’s say you adopted the Just One Lap strategy and decided you’re going to buy a broad-market, global index-tracking product. If the ETF you’re looking at says “South Africa – Equity – Large Cap”, you’re not in line with the strategy. You need to look for something that starts with “global”. You don’t want to see the words “Real Estate” in there. If you do, you’re off track.
The first two are pretty easy. Either dividends get paid into your brokerage account (the account where you bought your ETFs) every three months or every six months. The ETF issuer holds on to the dividends for you as the companies you hold within the ETF pay them. You earn interest until this distribution day and that interest is also paid to you.
Dividend withholding tax and the cost of the ETF is taken from this money before it’s paid to you. There are no more fees and taxes due once you receive this “distribution”.
“Total return” ETFs don’t pay the dividends to your account. Instead, they reinvest the dividends on your behalf. We explain total return funds here. It’s important to remember your dividend withholding tax and ETF fees are also deducted from these dividends, even though they don’t get paid to you.
Keep this in mind when you sell your total return ETF. You will be liable for capital gains tax if you sell your ETF at a higher price than you paid for it outside of your tax-free investment vehicle. Make sure you’re not taxed on the capital gain from reinvested dividends. That would mean you’re being taxed twice.
- Portfolio currency
Luckily for us, we can buy ETFs that invest in economies all over the world using rands and our local brokerage account. However, the currency of the portfolio introduces a degree of risk (and possible reward), so it’s important to pay attention to your portfolio currency.
Before the ETF issuer buys shares in offshore funds, they convert your rands to the currency of the fund. For the sake of this example, let’s say the currency of the fund you’ve chosen is the US dollar. As you probably already know, the price of the exchange rate between the rand and the dollar changes constantly. If you pay R16.50 for one dollar and the price goes up to R16.60, you actually make a bit of money, even though our currency has weakened. It’s weird, but it works. Sadly, the opposite is also true. If you pay R16.50 and the rand strengthens to R16.40, you’ll find yourself out of pocket without even factoring in your actual investment.
This can be really confusing, especially if you’re just starting out. Weirdly, it becomes less confusing once you see it happening. If you have a demo account or a few rands you can afford to lose, it’s worth buying an offshore ETF (we like the Ashburton 1200) to see how this works in real life.
To be included in an index and the ETF that rides along, companies have to meet certain criteria. When they no longer do, they get kicked out of the index. In the real world, the ETF has to follow along, kick the company out and replace it with a new one.
Rebalancing refers to the process of giving each company the weight it’s supposed to have in the index. You want an ETF that keeps pace with the index, but not one that chops and changes all the time. Chopping and changing is called “churn” and we don’t like it because it comes at a cost to us investors. Read more here.
A quarterly rebalancing is pretty standard.
ETFs are sneaky when it comes to fees. You don’t ever physically pay the cost of an ETF into an account or see it on a statement. As we mentioned earlier, the fees are deducted from your dividends before you receive them. The fees also have to be subtracted from the overall performance of your portfolio for the period, along with inflation, to get to the return you actually received. Therefore lower is better. We discuss ETF fees in detail here.
Where do I find an MDD?
All ETF issuers have to publish these documents and you can get them directly from the issuer’s website. Those would be companies like Satrix, Sygnia, 1nvest and Cloud Atlas, who make the ETFs.
However, etfSA publishes the latest MDDs here. We like this resource better since all the documents are in one place, making it much easier to compare different ETFs.
*Sometimes they’re called fund fact sheets.
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