ETF methodologies are getting smarter and our investible universe now includes the whole world. With a growing number of An asset or item that is purchased with the hope that it will generate income or appreciate in the future. In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth. In finance, an investment is a monetary asset purchased with the idea that the asset More options, choosing the best ETF for your In the world of finance, a "portfolio" is a term to describe all the assets you own. It includes shares, cash, bonds, physical property, your retirement savings, your tax-free savings and any other financial instruments you might hold. It excludes insurance products like life insurance. Your overall portfolio can be made up of a number of portfolios held at different requires a fair bit of digging. ETF methodology is your shovel.
JSE investors can choose between An exchange-traded fund (ETF) is a listed investment product. ETFs are usually index-tracking products, which means a single ETF share gives the holder exposure to an entire index—sometimes consisting of thousands of individual shares. ETFs give investors the opportunity to invest in entire markets easily and cheaply. ETF units (also called shares) can be bought wherever you buy ordinary shares, More weighted by Market capitalisation refers to the size of a company within a market. It is determined by multiplying the number of shares the company issued on the exchange (which is the market) by the current share price. This metric is often used when putting together an index. Companies with a higher market capitalisation take up more space in the index. and smart beta ETFs. Over the years, the scope of smart beta ETFs have broadened substantially. The number of In the world of index-tracking investments, a vanilla index refers to an index weighted by market capitalisation. That means big companies take up more space in the index than small companies. It's called 'vanilla' because it is the 'plain' kind of ETF. The alternative to vanilla ETFs are 'Smart ETF's' which use a range of different methodologies to select shares. ETFs have also increased. In this environment, understanding an ETF’s methodology and the impact it would have on your portfolio is critical to good decision-making.
ETFs weighted by market capitalisation—colloquially called vanilla ETFs—invest more of your money into bigger companies. For that reason, JSE giant Naspers currently represents 22.16% of the Satrix Top 40. The company’s representation in the An index is a tool we can use to measure movement over time. In the stock market, we use indices to track the performance of a selection of listed companies. This could include all the companies listed on the market, or all the companies in a certain sector. In inflation, we use an index to track the price of certain changes as it grows in size or loses value. A company’s contribution to an ETF is determined by multiplying the number of shares the company issued by the share price. If a company’s share price falls terribly, think Steinhoff, the amount of space the company takes up in the ETF shrinks. If the company’s share price continues to struggle, it gets booted out of the ETF and replaced by a more promising prospect.
When market capitalisation ETFs invest your money into the underlying companies, the ETF allocates a bigger percentage of your money to companies that are bigger. Of every R100 invested in the Satrix Top 40, R22.16 will therefore go towards Naspers.
Smart beta ETFs
Smart beta ETFs employ different methodologies with varying levels of complexity. Any ETF whose constituents aren’t chosen purely on market capitalisation is considered a smart beta ETF. These days, factor-based investing and risk weighting are all the hype.
NewFunds, who issued the first multi-asset MAPPs ETFs, now offer ETFs weighted by the amount of risk each company contributes to the ETF. They also recently introduced ETFs that move into cash during periods of market Volatility refers to changes in share prices over a short period. If an investment is highly volatile, the value of the investment goes up and down all the time. This is considered risky, because it's difficult to predict what the share will be worth when you are getting to ready to sell. or when the market drops by a certain percentage. With a greater focus on risk, these ETFs aim to protect portfolios during tough times. Weighting is no longer just about company size. It now refers to the amount risk each share contributes.
Factor filters are also on the rise. The theory is shares that exhibit certain characteristics perform better or worse during certain market conditions. The characteristics, or factors, are:
- Value: companies whose share prices cost less than their actual worth
- Momentum: share prices that have gone up or down are likely to continue to do so
- Size: what percentage of the ETF is allocated to which shares
- Quality: shares that meet certain favourable financial criteria or, in the case of the CoreShares Aristocrats products, shares that have paid a consistent dividend for a set number of years
- Low volatility: shares whose prices don’t fluctuate much
Some issuers offer ETFs that only focus on one of those factors, like quality, momentum or low volatility. Others combine these factors inside the ETF. The NewFunds volatility managed ETFs, for example, combine momentum characteristics with low volatility shares to find their investible universe. The CoreShares SMART ETF combines all of these filters,
How does this affect the ETF I choose?
How much money you’re willing to invest in a single company is no longer the most important consideration when choosing an ETF. A better starting point would be whether you’re happy with market return. If you’d prefer to take some chances to outperform the market over time, you’d lean more to smart beta ETFs. During certain market conditions, you’re taking on factor risk that might not be rewarded. If everything works as it should, you’d be rewarded for that risk when the market turns to favour your chosen factor.
As always, costs remain critical in your investment decisions. To avoid surprises, never buy a product you don’t understand completely.
How do I know what methodology I’m investing in?
When you research ETFs, do a Google search for the latest fact sheet for each ETF. The ETF methodology is disclosed in the fact sheet. You can find a library of the latest fact sheets on etfSA.co.za.