We previously wrote a short and handy guide to investing in Exchange Traded Funds (ETF) in the Philippines, but if you’re looking for additional information or wondering if ETFs are fit for you, then continue reading below.
What are Exchange Traded Funds (ETF)?
An ETF is a managed investment fund that is traded on an exchange, such as the Philippine Stock Exchange (PSE), intended to track an index or a basket of assets.
To explain this in clearer terms, we’ll break down this definition for you.
Managed Fund?
As a managed investment fund, an ETF is similar to mutual funds or unit investment trust funds in the sense that the funds are managed by a group of investment managers in a financial institution. The role of ETF fund managers is to “track” an index or a basket of assets.
Track an Index?
Most investment managers handling a “regular” fund try to beat the index in order to achieve “alpha” returns. This simply means fund managers trade and invest with the goal of outperforming or beating the benchmark index.
In contrast, fund managers of ETF simply track or mimic the index. By “tracking the index”, ETFs are supposed to merely replicate, not beat, the performance of an index. Thus, you can expect that the returns of an ETF will be very similar or close to the return of the tracked index.
The index that the ETF tracks could be any asset index. For equity or stock ETFs in the Philippines, the benchmark index that the ETF could track might be the Philippine Stock Exchange index (PSEi), the equity index in the Philippines comprised of 30 publicly traded companies.
ETFs are rarely or not actively traded since the benchmark index itself may not drastically change composition every time. It can thus be expected that the returns of ETFs may sometimes be lower or close to the actual index performance. For example, if the PSEi grew 10% after 3 months, you can expect an Equity ETF in the Philippines tracking the PSEi to book returns very close to 10% as well. The difference in returns may be partly due to imperfect rebalancing of the index and transaction costs associated with trades of the fund.
Traded on an Exchange?
What this means is that the ETF can be bought and sold at an exchange, like the Philippine Stock Exchange.
Compare this with Mutual funds and UITFs that are not traded on an exchange. Mutual funds and UITFs are valued at the end of every trading day — using the Net Asset Value per Share (NAVPS), in the case of mutual funds, or Net Asset Value per Unit (NAVPU), in the case of UITFs.
The NAVPS and NAVPU are the prices used to purchase or sell shares or units of the mutual fund or UITF, respectively. Investors, however, can only purchase or redeem these funds at the end of the trading day.
In contrast, an ETF is similar to stocks in the sense that its price may vary anytime during the trading day. Since ETFs are traded, investors may buy or sell ETFs anytime during the trading day. Investors need not wait for the end of day to purchase or redeem ETFs.
As per the approved PSE guidelines, Philippine ETFs must issue a real-time value of the fund, called the iNav, every fifteen (15) seconds. Hence, investors can know the value of the ETF in real-time and can make decisions (like buy or sell) anytime during the day.
(For a more detailed comparison of ETF versus other funds, read our article: ETF vs. Stocks, Mutual Funds, UITF, etc.)
What are the Benefits of Investing in ETF?
The primary benefit of ETF is diversification. ETFs offer an alternative to those looking for more investment options aside from stocks, bonds, mutual funds, or UITFs. Because of diversification, investors can lower the risk of their overall portfolio since they can spread the risk among various investment assets in the portfolio.
For example, if an investor is directly and fully invested in one stock and that stock tumbled in price, the investor stands to lose some amount of money. But if the investor is 50% invested in that stock and 50% invested in an ETF, the amount of loss may be lower because the ETF will have a different performance from the stock. This is what we mean by “reducing the portfolio risk”.
ETF investors may also benefit from higher income through trading. Like stocks, ETFs are traded daily and prices change anytime during the day. This gives traders an opportunity to buy or sell an ETF — sometimes within the day — in the hopes of locking in gains due to constant ETF price movements. If traders believe that the index or the assets comprising the index may rise in the future, they can time the market and supposedly buy the ETF at a lower value and sell it later at a higher ETF price.
Another benefit of ETF investing is the ability to invest in a variety of assets at lower investment cost. This makes it cheaper and easier for retail investors to indirectly invest in assets or stocks that may otherwise be expensive, if bought separately.
For example, an investor has to shell out around P15,000 just to buy the minimum number of shares of PLDT (TEL) and around P7,500 in order to buy the minimum shares of Globe Telecom (GLO). This means, investors must spend P22,500 just to invest in those two stocks.
With ETFs, an investor can spend P22,500 to indirectly invest in the PSEi, thus making the ETF investor an indirect investor not just of one or two stocks, but of 30 underlying stocks comprising the PSE index.
What about the Disadvantages of ETF Investing?
In the same way that diversification can lower the risk of the portfolio, diversification may also reduce the overall return of the investor.
For example, if an investor is fully invested in a stock that rose 50% in price, the investor gets to receive the full 50% benefit. In ETFs, if that stock is just one of several stocks being tracked by the index, the return will surely be lower because other stocks in the index that gained less than 50% will drag down the overall return of the index.
Another disadvantage is that the intra-day trading nature of ETFs may not be applicable to long-term investors. Long-term investors with an investment horizon of at least 5-10 years may find the daily prices of ETFs volatile, which could lead them to buying and selling ETFs in the short-term, thereby distorting their overall investment objective of long-term investing.
This volatility in ETF prices may be caused not by fluctuations in the index performance but by speculation and manipulation of a few players hoping to profit from intra-day price changes.
The trading nature of ETFs could also lead to a substantial disparity between the actual index performance and ETF prices. Thus, some long-term investors who prefer stability might find blue chip stocks or index mutual funds or UITFs (that are not traded) to be better suited to their investment objective.
What ETFs are available in the Philippines?
At present, only one ETF is available in the Philippines. This is the First Metro Philippine Equity Exchange Traded Fund (FMETF), offered and managed by First Metro Asset Management, Inc. (FAMI).
Buying and selling FMETF is the same as buying and selling any regular stock in the Philippines. You need to have a trading account with an accredited stockbroker and you need to input your order in your broker’s stock trading platform if you want to buy or sell FMETF.
Other companies such as Banco de Oro (BDO), Bank of the Philippine Islands (BPI), and other investment companies have previously said that they will launch their own ETFs in the future. We’ll watch out for those developments and will keep you updated so follow PinoyMoneyTalk’s Facebook page to be kept in the loop.
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