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, exchange-traded fund (ETF) issuers publish one for each fund at least once a quarter.
This week we help you unpack your sectoral exposure and the top 10 holdings in your MDD. The point of this exercise is to avoid concentration risk. Concentration risk is when you have such a large part of your portfolio invested in a single sector or company that a wobble in that sector or company can cause trouble in your portfolio.
We are going to compare three broad-market South African ETFs:
- The Sygnia iTrix Top 40 (share code: SYGT40)
- The Satrix Quality South Africa (share code: STXQUA)
- The CoreShares Top 50 (share code: CTOP50)
Reminder: ETF investments are share investments
If you think of investing as a gift, an ETF is the wrapping paper. It’s pretty and does its job, but it’s not the main event. What’s inside the ETF is really what matters. Each ETF invests in a number of companies according to the rules of the index.
Many ETFs cover the same market, but they don’t track the same index. If you hold all three, you might think you’ve diversified your holdings. However, inside each ETF is a number of companies. Comparing the sectoral and top 10 exposure of these ETFs will help you understand where exactly your money is going.
Start with sector allocation
Sector allocation tells an important story about where your money is going. Just like a lot of exposure to a single company’s share could put your money at risk, having too much exposure to a single sector introduces risk. If, for example, half your portfolio is exposed to the banking sector and there’s a 2008-style financial crisis in South Africa, half of your portfolio would be exposed to the financial crisis. Avoiding this type of single-event risk is what diversification is all about.
Below is a screenshot of the sector allocation of the SYGT40.
If you invested R100 in this ETF, R38 would go to the Materials sector. “Materials” are things we mine, like gold and platinum. When an ETF has a large exposure to the Materials sector, it’s investing in the mining companies that take things out of the ground.
Of your R100 invested in this ETF, R34 would go to the Consumer Discretionary sector. That’s the stuff we spend money on that we don’t need to stay alive, like clothes. A further R13 would go to companies in the financial sector, like banks and insurance companies. Now you know R75 of your R100 investment has gone towards these three sectors.
Compare that to the sector allocation of the STXQUA below.
Of R100 invested in the STXQUA, R38 would go to the Materials sector, while R27 would go to financial companies, like banks and insurance companies. That’s R65 of your investment accounted for.
Had you invested R100 in the SYGT40 and R100 in the STXQUA, R76 of your R200 would go towards the Materials sector. Your percentage exposure remains the same. However, your percentage exposure to financial companies now becomes 21%, taking up R42 of your R200. If you held the SYGT40 and wanted more exposure to Financials, this is good news. If you held the STXQUA and wanted more exposure to Financials, this combination of ETFs takes your further away from your goals.
Now look at your top 10 holdings
The top 10 holdings represent the 10 companies that take up the most space in an ETF. In broad-market ETFs that track companies listed on the JSE, it’s very likely that the biggest companies in the market will be present in all the ETFs. Once again, this is fine if you want more exposure to a certain company. However, if you wanted to diversify your investments by buying more than one ETF, you could actually end up holding a bigger slice of a single company by accident.
Let’s say you invested R100 in each of the three ETFs featured here. Your total investment amount would be R300. That R300 has to be split among the companies represented in each of these ETFs.
As you can see from the top 10 holdings above, some companies are present in all three ETFs. BHP Group takes up:
- 12.7% of the SYGT40
- 10.93% of the STXQUA
- 9.8% of the CTOP50
If you spread that across your R300 investment, overall BHP Group would take up 11% of your portfolio.
(12.7+10.93+9.8 = 33.4, but since a third of your R300 goes to each ETF, divide by 3.)
If you had hoped to hold less of BHP Group, buying more ETFs could actually end up doing the opposite.
This exercise is worthwhile for all the ETFs you hold that cover overlapping markets. Since ETF weightings change every quarter, you want to keep an eye on this throughout the year.
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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