When exchange-traded funds (ETFs) were introduced to the South African market 20 years ago with the launch of the Satrix Top 40 ETF in November 2000, they kick-started the local active versus passive debate.
Since then, the investment industry has evolved to blending the two approaches. Multi-managers and discretionary fund managers (DFMs) are now increasingly using ETFs as building blocks when constructing investment portfolios.
Three phases of development
Nerina Visser, financial adviser and ETF strategist at etfSA, says there were three phases of development over the last two decades.
The first phase was the launch of ETFs in 2000 to track vanilla equity indices.
The second phase saw the extension of ETFs to other asset classes, with the launch of the first non-equity ETF, the NewGold ETF in 2004.
‘That was an exciting time,’ said Visser. ‘It was about getting access to physical commodities via an ETF. It was about extending this cost-efficient and transparent investment structure to asset classes other than equities.’
The third phase saw index construction moving away from purely market-cap weighted indices to a full range of factor-based indices. The first example of this was the Satrix Divi.
‘Both the selection of shares for that ETF and the weighting of the shares within the ETF was based on dividend yield,’ said Visser. ‘In the case of the Satrix Top 40, you invest in the 40 largest shares listed on the JSE. The Satrix Divi gives you the 30 shares out of the top 100 with the highest forward dividend yield.’
The use of ETFs in multi-manager portfolios
All of these have now become building blocks for asset allocators.
‘ETFs are an incredibly important element of our portfolio construction,’ said Iain Anderson, portfolio manager at Sygnia (pictured). ‘The ease of use and low cost means that using ETFs is an extremely efficient way to get the exposure we need at low fees.’
Anderson added that ETFs also provide flexibility.
‘For example, when we are investing in global equities, we implement the construction of the portfolio on a tactical asset allocation basis, using ETFs in the international equity market. Some of the ETFs we would use include the MSCI World, which gives you broader exposure, [and] very specific US ETFs such as the S&P 500 and the MSCI US.’
Yusuf Wadee, head of ETFs at Satrix, says it comes down to the old adage that asset allocation is the biggest driver of performance.
‘When it comes to ETFs, we usually see asset allocation themes such as the core-satellite strategy,’ he said. ‘It’s a way to stack your building blocks.’
Wadee explains that a multi-manager or DFM could start with a very low-cost and efficient core such as the Satrix Top 40 ETF or the Satrix MSCI World ETF.
‘Then, when looking at the satellite component, the DFM could have a tilt towards a particular manager, portfolio or style managed by the DFM’s managers of choice,’ said Wadee.
Wadee says a second approach could be to use the same core as above and then at the satellite level, continue to use ETFs but to branch out to more focused strategies.
‘For example, two years ago, we launched the Satrix Nasdaq ETF, which gives you exposure to the biggest tech stocks in the US. Fund managers could use that as a satellite strategy, especially if they want to express a view to a particular theme.’
Anderson says the evolution of the industry means that you can blend active and passive management, although in South Africa, there is still a strong demand for active fund management.
However, he notes that the rise of the millennial investor is likely to be a factor driving further growth in the industry.
Globally, a survey by Charles Schwab in 2018 revealed that nine out of 10 millennials saw ETFs as a vital component of their investment strategy.