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iShares Australia’s Head of Wealth, Alex Zaika, covers off on the basics of exchange traded funds including their history, growth, how they work, their benefits and risks and practical tips for investors interested in these products. Access the presentation slides here.
CPD accreditation note: This activity has been accredited for continuing professional development by the Financial Planning Association of Australia but does not constitute FPA’s endorsement of the activity. Accreditation number 010102 for 0.75 hour.
The information below was published on 17 May 2018.
Alex Zaika, Health of Wealth at iShares Australia, covers many of basic and technical queries from nabtrade’s recent exchange traded funds 101 webinar including whether these products use leverage, pay dividends and franking credits and the impact of currency movements on certain funds.
By Alex Zaika (AZ)
I recently spoke at nabtrade’s exchange traded funds (ETFs) webinar and it was great to see the level of interest and engagement among retail investors and self managed superannuation fund trustees about these products.
In the recording, I explained the very basics of ETFs including their history, their rapid growth overseas and in Australia, understanding their liquidity and the role of the market marker and considerations when investing in these products.
There were many great questions which I didn’t get a chance to cover from the audience. In this Q&A I will go through ones which I have the expertise to answer.
Question: What is the minimum amount you can invest in ETFs?
AZ: The Australian Securities Exchange (ASX) generally requires a $500 minimum marketable parcel of shares to be purchased.
Question: Is leverage used within some ETFs?
AZ: Traditional ETFs do not use leverage however some issuers do offer levered and inverse products. In Australia, if an exchange traded product employs leverage it is likely to have the term ‘hedge fund’ in the name. At the time of writing only one ETF issuer Australia has issued levered products.
Question: Using your ship analogy [from the webinar], if the ship sinks what happens to the containers? If the assets are held in trust, does that mean that if the ETF provider fails can investors receive the assets?
AZ: If the investment manager of an ETF were to collapse, a new investment manager could be appointed by the Responsible Entity. As the assets are held with a custodian, they are protected from bankruptcy and the assets could be redeemed and delivered back to an Authorised Participant
Question: How do investors know if an ETF is synthetic ETF, a physical ETF and an active ETF?
AZ: In Australia, a synthetic ETF will be clearly labelled as being synthetic in the name. An example in Australia is QCB – BetaShares Commodities Basket ETF – Currency Hedged (synthetic).
Question: At what point are the underlying assets purchased? After market close? If that is the case then could the price being paid be higher (if the market is rising) or lower (if the market is dropping) than the closing price of each asset?
AZ: The role of a traditional ETF is to track a benchmark as closely as possible irrespective if the benchmark is rising or falling. A portfolio manager is permitted to purchase or sell securities at any time throughout the day to minimise transaction costs and maintain flexibility.
Question: Is there a governing body checking that ETFs are being operating legitimately?
AZ: ETFs are regulated by ASIC – the Australian Securities and Investments Commission.
Question: Should I spread my ETF purchases across several ETF providers?
AZ: ETFs are typically diversified investment portfolios. If two ETFs track the same benchmark, it would make little sense to hold both ETFs as this would double up on trading costs.
Diversifying across ETF issuers makes sense if ETF issuers have a particular expertise or offer differentiated products.
Question: What are the pros/cons of purchasing an ETF on your domestic exchange vs on an overseas exchange?
AZ: Trading on the ASX is relatively simple and low cost as traded are executed in our local time zone and settled in one currency.
Offshore trading opens up a much bigger investment universe of investment options however trades may need to be executed in different currencies and time zones. The cost of trading can also be more expensive and it introduces currency risk.
Question: Does buying and selling an ETF impact on the price of the stocks inside it?
AZ: The market price of stocks is determined by supply and demand. ETFs represent less than 5% of the world’s equity market and less than 2% in Australia. To date ETFs have not been observed to influence the price of stocks however if an ETF was large enough, then buying and selling within the fund could influence supply and demand and ultimately the price of a stock.
Question: When investing in overseas market ETFs is it important to hedge the currency exchange risks - if so, how do you do it?
AZ: ETFs are either currency hedged or not. Currency hedged ETFs remove the risk of currency fluctuations within the ETF itself and there is no additional work for investors. The decision to hedge or not is yours to make as ETFs are simply building blocks for your portfolio.
Question: Don't ETFs go up less in value, compared to a single stock?
AZ: An ETF is comprised of a diversified basket securities e.g. stocks or bonds. If the basket of stocks were to increase in aggregate by 1%, you should expect the value of the ETF to increase by the same amount less any fees.
Comparing a diversified ETF to one single stock is a poor comparison as you are not comparing apples with apples. A single stock could rise more than an ETF and can certainly fall more than an ETF.
Question: Do ETFs have dividends or are their sole purposes to just be traded?
AZ: If an ETF holds securities that pay dividends or coupons, you should expect the ETF to pass these through to investors in the form of distributions. ETFs can be used for both regular income and trading.
Question: Do ETFs keep the franking credits?
AZ: No, ETFs pay distributions and associated franking credits are passed through to unit holders. The amount of franking credits (if any) are stated in annual tax statements sent by ETF issuers to investors.
Question: With the daily holdings disclosure, are they updated intraday in the iShares/BlackRock website or is it just the prior day’s end of day holdings are disclosed?
AZ: Portfolio holdings are updated once per day via the iShares website. These can be downloaded or viewed at any time by investors.
Question: When buying an ETF through iShares for let's say S&P 500 exposure, what are the effects of the currency on this investments? Are there hedged options and if so how is this hedging done?
AZ: IVV – iShares S&P 500 ETF tracks the S&P 500 index and is unhedged meaning investors are exposed to the impact of currency.
IHVV – iShares S&P 500 AUD Hedged ETF is the equivalent currency hedged ETF. Hedging is implemented by the portfolio management team using currency forward contacts.
Question: Is there a Korean ETF which includes Samsung?
AZ: Yes, at the time of writing IKO – iShares MSCI South Korea ETF holds Samsung with a weight of 23.78% (as at 11 May 2018).
Question: Does iShares have an ETF that tries to outperform an index? If not, why?
AZ: Smart beta ETFs are designed to seek outperformance or reduce risk. In Australia, we offer two smart beta ETFs that seek factor-driven outperformance over the long term. They are:
Question: So if you use the iShares Core Builder, do you have to buy the ETFs on nabtrade?
AZ: iShares ETFs are ASX listed so they can be purchased or sold through any broker.
Question: If I buy an iShares ETF through nabtrade, do I pay commission to nabtrade as well as Blackrock?
AZ: There are no commissions paid to BlackRock. The only fee charged by BlackRock is the investment management fee.
Thank you again to everyone who attended the webinar and I hope I’ve demystified the world of ETFs for you. nabtrade and iShares are planning more ETF webinars in the future and I hope to see you there.
Alex Zaika is Director and Head of Wealth for iShares Australia. His responsibilities include helping private client advisers build better investment portfolios with iShares and supporting the iShares distribution efforts nationally.
Alex joined the firm in August 2015 from Barclays Capital where he helped institutional investors with hedging and smart beta solutions. He holds a Master in Applied Finance, Diploma in Financial Planning and is an Accredited Derivatives Adviser.