Low-cost investing with ETFs
I was recently asked to contribute to an article for The Edge Malaysia titled: Low-cost investing with ETFs. The interview took the form of a Q&A which I list below. You can find a PDF and weblink to the published article at the end of this piece.
1) Although ETFs are often seen as a short term investment tool, do you think ETFs can be used as a tool for retirement planning? Why or why not?
Yes, they definitely should be used; sadly this is not always possible due to local regimes. Our MPFA for instance does not allow the direct use of an ETF, however the underlying manager can utilise them. ETFs have a low TER (Total Expense Ratio) and that makes them ideally suited for use as a long term tool.
On the MPFA site you can find a list of the FER (Fund Expense Ratio), akin to TER, of the available funds. The average FER for Equity funds is 1.57%, and 1.37% for Bond funds. These are above average fees for at best closet index-trackers and at worst woeful underperformance. In other markets people can use ETFs in their retirement plans at costs as low as 0.10%pa. In Hong Kong we have the HK Tracker fund (2800); it has a TER of 0.10%, while a typical MPF fund clone of the HK Tracker has a FER of 0.80%. I’m not sure why a ‘tracker of a tracker’ costs an extra 0.70%pa, why not just allow direct access to the underlying ETF?
In general, ETF trading costs are minimal but this can be a double edged sword as people might be tempted to use them for short term tactical punts. Given the long term nature of retirement funding and drawdown planning, there seems little need for tactical application.
2) Should investors allocate a larger portion of their portfolio into ETFs as compared to 10 years ago? Why or why not?
Yes. W live in a low yield and low return environment and this is set to continue. When you look at the consensus longer term capital market assumptions, then cost must be paramount. Logically, when faced with modest capital market assumptions, it follows that active managers will be hard pressed to deliver value for their fees. The hedge fund industry in particular looks very expensive in this context.
If one held a low cost MSCI World Equity ETF then the worst that can happen is that one gets the total market return less the TER and any platform cost. I’d take this rather than risk my retirement to an active manager who thinks he can beat the market. Empirical evidence tells us that this is not the case.
3) How should investors strategise their investment portfolio if they want to invest in ETFs? Could you suggest the allocation in percentage terms in different asset classes, such as equities, mutual funds, ETFs, gold and property?
One should hold a balanced portfolio that is appropriate to your attitude to risk and revisit (rebalance) this regularly. I am 46 and my entire UK pension is sat in Vanguard’s Target Retirement 2035 index fund, this fits my plans. At present the fund provides an 80% global equity allocation and a 20% global bond allocation. It is appropriate for my age and attitude to investment risk and costs me 0.25%pa TER.
Some people like to use tilts to gold and property to diversify; I am not one of them but it is an option for those that do. REITS and physical Gold ETFs are fine in this context. If prefer to tilt to factors empirically proven to out-perform such as size and value.
4) Could you name 3 ETFs (whether Singaporean or foreign) that you would recommend to your clients? Could you state the reasons for picking these ETFs?
I personally hold Vanguard and iShares. If a target date ETF/Index fund is not available, then one can use ultra-low cost ETFs to get the appropriate risk-adjusted exposure via the MSCI World, S&P 500, Emerging Market Equities. Bond exposure can be had via Total Bond and Emerging Market Bond funds.
5) Do you think there are enough ETFs in the market for investors to choose from? Why or why not?
Yes. However, in certain regional markets there is a bias to ‘home’ and or regional exposures. Some providers such as Vanguard and iShares have a very low retail footprint in markets such as HK. Institutional investors can use ETFs listed overseas but retail clients are oft restricted to ETFs listed on their domestic exchanges. There is also a shameful lack of Index Mutual Funds (UCITS) available to the local retail market. This is improving but is still a frustration as it plays into the hands of the bank-dominated distribution channel.
What we need is better distribution and cost transparency. In markets such as the UK, US, Australia and New Zealand there are multiple wrap platforms for investors to use. This is essential for price competition and innovation. One can have access to the lowest cost ETF available, but if the implementation cost is high then the low-cost benefit is eroded. Also such platforms often provide inbuilt tools for risk profiling, lifetime cash-flow planning and the like. Such change will require local regulatory support.
6) How should investors pick an ETF to invest in? For example, do they look at the sectors the ETFs invest in, or do they pick syariah vs conventional ETFs?
The first step is to accurately define one’s attitude to investment risk and to consider factors such as time to retirement, income/capital needs in retirement, anticipated inflation and return assumptions. I would suggest that the average person would be best served by seeking assistance in this area from a fee-only advisor that is appropriately regulated and qualified.
Providers such as Vanguard have solid principles that focus on: Goals, Balance, Discipline and Cost. These 4 factors are solid guidelines.
I recently returned from a business trip to the US where I met a seasoned investor called Jeff Troutner. Jeff has three words writ large (literally) in his office: Knowledge, Confidence and Discipline. We can all learn from this. I was also honoured to see Professors Eugene Fama and Kenneth French present. Professor French cautioned "Resist the siren call of Active". He might be on to something....
You can read the final article here