Warren Ingram and Chris Rule dive into the world of exchange-traded funds (ETFs), exploring their transformation from simple index trackers to actively managed portfolios. They break down the benefits of using ETFs for diversified investing, discuss the differences between active and passive ETF strategies, and highlight key considerations like costs and transparency.
Takeaways
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Have a question for Warren? Don't forget to voice note your questions through our WhatsApp chat on (+27)79 807 8162 and you could be featured in one of our episodes. Follow us on Twitter, LinkedIn and subscribe to our YouTube channel for more Financial Freedom content: @HonestMoneyPod
Warren Ingram and Chris Rule dive into the world of exchange-traded funds (ETFs), exploring their transformation from simple index trackers to actively managed portfolios. They break down the benefits of using ETFs for diversified investing, discuss the differences between active and passive ETF strategies, and highlight key considerations like costs and transparency.
Takeaways
For more valuable insights from the 10x team, click here.
Have a question for Warren? Don't forget to voice note your questions through our WhatsApp chat on (+27)79 807 8162 and you could be featured in one of our episodes. Follow us on Twitter, LinkedIn and subscribe to our YouTube channel for more Financial Freedom content: @HonestMoneyPod
The Honest Money Podcast is powered by 10X Investments, a licensed financial services provider. Consult with your financial advisor and let's 10X your future together.
Speaker 2:Welcome to Honest Money. We're talking all things exchange-traded funds today, and it's a topic that's very close to my heart, something that I've kind of been talking about and suggesting and personally investing in, for it feels like centuries, but it's only decades, and I'm very, very happy to have Chris Rule, who's head of client solutions at 10X Investments, to join me, because he's an expert on this. I'm just a talking head, chris, so good to have you on the show.
Speaker 3:No, thank you for having me, Warren. Look forward to the chat.
Speaker 2:I feel like we should have already done 30 or 40 of these podcasts with you. I'm so surprised that it's our first one, and so for our listeners. I've known and worked with Chris a long time. No-transcript is that he looks for the best return, not the best philosophy. It's all about an outcome, and that, for me, is really important. So that's about it, the nicest. I'm going to be to you today, chris, and now we can get into the topic.
Speaker 3:Yeah, checks in the post. Thank you very much.
Speaker 2:Chris, I think maybe just to kind of let's go back, you know, to go forward I mean, we want to talk about exchange-traded funds and how they've evolved and where they're potentially going to but maybe just to start with what they are and kind of you know why we got to where we are today.
Speaker 3:Yeah, I mean it's a good place to start. Always and I think you know people talk about ETFs and exchange traded funds and the acronym gets in the way of what it really means. Often, and in a sense it's a very simple idea means often and in a sense it's a very simple idea. It's the idea that you can access a basket of shares or bonds or a multi-asset portfolio through one single investment on your stock broking account and that's really the principle of it. It started quite some time ago. The first exchange traded fund was actually an idea. State Street S&P 500 is kind of the first big ETF that hit the screens. It was an idea that you could get exposure to US equities very quickly by just buying this one instrument. So if you were a fund manager or if you were a big institution and you needed quick access to US equities, you could buy the State Street Spider S&P 500.
Speaker 3:I mean just some interesting facts. To this day, that's one of the most liquid instruments in the world, just to give you an idea of how far along that's come since then. So it's more liquid than some of the large heavy cap shares we talk about. But really in our market, if we bring it home, it's a relatively new market. It's only about 20 years old. The first ETF in our market, if we bring it home, it's a relatively new market. It's only about 20 years old. The first ETF in our market was the Satrix 40. Everyone kind of knows about the Satrix 40. That was actually interesting. Now we know Satrix is wholly owned by Sunland but that was the JV between the JC at the time, gensec Bank and Deutsche Bank and that kind of emerged into a Satrix wholly owned entity at a point.
Speaker 3:But the idea is really simple and where we are now is that in our market most of the ETFs are actually collective investment schemes, which means they're unit trusts.
Speaker 3:So it's a unit trust with trades on market and as an investor you can come and buy it in your stockbroking account alongside, let's say, your share portfolio or if you already have other ETF holdings, and in one single investment you can get access to in some instances only 40 shares, like in our top 40, or in some instances close to 9,000 shares, like a total world strategy which is just massive diversification. That as an individual investor, even as an institution interestingly, a large South African institution can't really access total global markets as efficiently as some of the ETFs that you can buy as an individual on screen. So that's kind of really what it's all about is accessing diversified basket of shares really efficiently on your stockbroking account and that's kind of the exchange traded part about it. It trades on the JSC just like a share and that's really the only difference between it and a normal unit trust. I think that often gets caught in the noise that these opposing vehicles, but they're actually identical. They do the same thing for clients.
Speaker 2:And I feel that that's maybe just something to spend a second on is there was a time when exchange-traded funds were launched around the world, but I guess particularly here, where they were significantly cheaper than their competitor unit trusts. But I think unit trusts industry doesn't stand still. So certainly nowadays you can find exchange-traded funds that are quite expensive and unit trusts that are quite cheap. And so, just for someone listening, don't get fixated on the idea that an exchange-traded fund is always cheaper and a unit trust is always more expensive. You will need to do a bit of homework to know what you're buying and to know what it costs to run that. And the jargon for that is the total investment charge, so the actual or the TER, but really the running costs inside the thing that you're buying.
Speaker 2:And generally, the bigger, the more diversified, let's say, the more generic the index is, that's being tracked you would expect that the costs are quite low. So that spider that Chris is talking about will be really low cost. I think you can get them down to 0.001% or something overseas, and it's costs we can only dream of in South Africa. You know they're so big in the US that they can get economies of scale and unfortunately, our investment base is so small that our costs will always be higher. But the reality is that you know these things are now cheap. But you know you could easily find a good, high quality index tracking unit, trust being as cheap, and sometimes cheaper, than a small exchange-traded fund.
Speaker 3:No, exactly right. I mean, I think some of that is due to the legacy of ETFs. When ETFs were originally launched, they were quite restricted in terms of they had to track an index globally. In terms of they had to track an index globally, so you would be forced into the index tracking mandates, which are typically a lot cheaper than active mandates, and so there was this obsession with, well, etfs are low cost and unit trusts or mutual funds are expensive, but that was actually more to do with the mandate that drove those funds. And so where we found ourselves now is what you actually have to understand is the mandate of the fund, and you might find that an ETF is exactly the same cost as its unit trust equivalents if the mandate is the same.
Speaker 3:The one thing ETFs do have is a really efficient scaling and creation and redemption mechanism, so it's a bit of a technical kind of portfolio piece, but basically, in a unit trust, all the costs are borne by the portfolio when money comes in and out of it. In an ETF, those costs are actually borne by the investor who comes in and out of that portfolio, and so the fund itself is isolated from those costs, and they tend to be more efficient vehicles because of that mechanism. It's a very slight nuance, but that's kind of the only material difference. Otherwise it should be all else equal, and we certainly do that in our business. We say, well, we've got an ETF that tracks the top 50 and a unit trust that tracks the top 50. We charge the same fee and put clients in the same place. So yeah, it's an interesting point. I agree. Don't get hung up on this idea that ETFs are cheap and unit trusts are expensive. I think that's long gone.
Speaker 2:So now we're in a position where we know what there are, but this financial services industry never stands still and I think quite a lot has happened over the years to kind of move exchange-traded funds forward, and now there are hundreds, if not thousands of them and new ones being issued every day around the world. Of them, and new ones being issued every day around the world, and I guess it starts with, maybe, regulators and the way that regulations have adjusted to these now fairly mature vehicles.
Speaker 3:Yeah, that's right. I mean I'll hone in on our market. Our market the regulation was very constrained. Initially there were, etfs could only be index tracking vehicles and even to the extent where you know how ETF issuers could bring different products to market prior to 2017, if you weren't a global bank with a global balance sheet and you were able to deal in foreign currency, you couldn't actually launch a foreign ETF. So that kind of blew open in the 2017 budget speech. So that was a big change, and that's when you kind of saw launch a foreign ETF. So that kind of blew open in the 2017 budget speech. So that was a big change. And that's when you kind of saw all the global ETFs come into market.
Speaker 3:It was post that and then, more recently, we've seen that ETF landscape liberalized to now say, well, you can have actively managed ETFs, and it's almost very simplistically just liberalized to say, well, anything that you can do in a unit trust, you can now do in an ETF, whereas previously it could only be index tracking.
Speaker 3:And so, therefore, active managers and different kinds of portfolios didn't really come to market in the ETF space. Multi-asset solutions, for example, where you want flexibility on asset allocation those didn't really come to market because you couldn't do that, and so, yeah, the regulation has changed and it often drives product innovation. That active piece has happened recently in our market probably two years prior in global markets and you just see new, different kinds of products coming to market, new, different kinds of exposures coming to market. I mean, exposure is a key thing there, because really what it's about is giving investors exposures to different kinds of assets and different kinds of returns and outcomes that they otherwise couldn't get if they were just trying to invest on their own again through their stockbroking account. That's the important piece, I think.
Speaker 2:And so what's interesting to me is that you know my imagination. When that regulation changed in South Africa, I thought you know every big unit trust company that manages balanced funds and the like would rush to launch a bunch of their own. You know actively managed exchange-traded funds and I feel that they've been quite slow. The bigger I don't know criticize, but the bigger older players haven't rushed to the market and issued ETF versions of their big unit trusts.
Speaker 3:Yeah, it is interesting. I thought we probably would have seen more by now. Look, the initial ETF providers were always going to be better positioned to come to market quickly because they know the capital markets, they know the regulatory process. You know we've been doing that for I don't know 13, 14 years at 10X, and you know the big incumbents who don't have ETF businesses have never done it. So, even though they've got all the smart guys in the building, they're just not familiar with the rules of engagement. So it is interesting and some relatively sort of left field products have come to market since we launched. But I think you know the gaps that are being filled at the moment are the ones that needed to be. The gaps that are being filled at the moment are the ones that needed to be.
Speaker 3:So it's, in a way, that the capital markets free markets is doing its job, because what you've seen since we've changed to actively managed ETFs is, instead of another high equity fund, what you're seeing is income funds coming to market. And why is that? Well, it's interesting because ETFs from inception, the idea was efficient exposure to markets that were hard to get exposure to efficiently, and income ETFs represent that, because buying a basket of SA credits or buying even SA bonds, which are relatively illiquid. When you go far out and quite hard to trade and all these different fixed income asset classes, it's very difficult for even a stockbroking business who runs model portfolios to actually get that kind of exposure in a meaningful slag in small size.
Speaker 3:So again, what the ETF industry has done is, it said, well, how do we provide exposure that's hard to get to for investors? And I think that's where you've seen, you know, I think there's like three income multi-asset income ETFs that have come to market since the legislation's changed and so it maybe wasn't the standard kind of high equity multi-asset funds or stock picking funds that come to market and there's some distribution stuff that you could unpack and understand a bit better why some of that didn't happen. But certainly capital markets are doing their jobs in terms of understanding what clients are looking for and plugging those holes. And really that's what ETF innovation has always been about is how do we give people exposure to something that otherwise would be very difficult to get?
Speaker 2:people exposure to something that otherwise would be very difficult to get. So, chris, the one thing that you know about innovation for me is that we kind of. You know it's a bit like when the Model T Ford was first developed. You know you could choose any Model T Ford you wanted, as long as it was the black one, because that's the only one they made. And in South Africa, you know, as you said, the original ETF was Satrix 40, and it was an easy game. You chose it because it was the only thing. And now we're in a space where we've got a plethora of ETFs and now adding actively managed, and I think it's a very good thing. But the complexity creates a dilemma for the person listening, because what they don't know now is how do they decide to choose between an active ETF and or a passive ETF and what are the kind of things they should be thinking about?
Speaker 3:So I think it's interesting. I think you know you're right. The product development creates choice problem for investors and for clients. The reality is the ETF industry is still a long way behind. Let's say, for example, the CIS industry. There are quite literally thousands of unit trusts out there relative to I think it's about 170, 180 ETFs in the market. So it's got a long way to go to get to the kind of product proliferation we've seen in the unit trust market and the CIS markets.
Speaker 3:But I think the core principles that certainly we would always propose for and I mean this is not active versus passive or index versus active or ETF versus unit trust, this is a principle you can apply to all of your investing is understand what's in the portfolio At a fundamental level. What are you buying? Understand what's does it say. What's on the tin, is it inside the actual tin? Is that product true to that? And transparency plays a key role there, because if you're disclosing your holdings daily and an ETF says, well, I'm going to do this, you can actually establish whether they're doing what they say. So transparency and understanding of the fundamentals of that ETF product, not just looking at performance, for example, and saying, well, this did really well. I'm going to buy it. Understand why did it do well and what are the assets that make it up. Transparency is critical to making that kind of evaluation as an investor, and this stuff's disclosed on websites every day, so it's not like you can't get access to it. If you go to our website, click down, see our holdings. So understand what is in the ETF. What are the asset classes, what is it trying to do? What is it trying to achieve? Not just looking at performance. Use the transparency as a mechanism to judge independently are they doing what they say they promised they're going to do, whether it's index tracking or active.
Speaker 3:And then, obviously, the cost is still a critical piece. So costs there's a really interesting statement that came out of Morningstar Research, the global research hub, and it was echoed locally. It says costs are the single largest determinant of a fund's future success, so it is going to be an important driver of your future outcomes. I'm talking over, like multi-generations, 10, 20, 30 years. Costs is going to be a contributor or a detractor from your investment returns, and whether it's an ETF or just because it's an ETF almost to Warren's point doesn't mean it's low cost, and this is going to be a challenge with AM ETFs and the actively managed ETFs that come to market. So, really, transparency, understanding the underlying investments costs, and then the big driver of certainty of return is always going to be diversification. This should be a diversified portfolio. Now it's interesting None of this has been like buy it because it's an index tracker or buy it because of this reason.
Speaker 3:Active versus passive. Actually understand those core components of what should make up your investment portfolio and then keep an eye on it and monitor it. These things change and in the actively managed world they change more. So in an index tracker, you always know we're going to buy the top 50 or the top 40, whatever the number is, and these are our capping rules. We're not going to hold more than this. But in the active world, you really do need to keep an eye on your portfolio and understand if there are changes. Why are there changes and is there undue risk in those changes? So, yeah, all of those components are really important, I think, when you're looking at ETFs.
Speaker 2:I 100% agree, and so I'm going to ask you my last question, which is my favorite surprise question for all new guests to the show, and I'll give you a little bit of time, while I do a summary, to think about it. But if you were to meet the 21 year old Chris now, with the benefit of life experience, what would be the one life lesson you would love to teach yourself? And it can be about money or it can be about anything else. So chew on that, and I think, for everyone else, I think just you know, when you look at the space and you look at exchange-traded funds, you know, don't be put off, because you see a lot happening in terms of choice and a lot of decisions to be made. I think you can quite quickly filter out a lot of investments that just choice and a lot of decisions to be made.
Speaker 2:I think you can quite quickly filter out a lot of investments that just won't be appropriate for you. If you're going for highly diversified global investments, then choosing something that's a specialist in just in China, or just a tech share or just an index tracking ETF focusing on tech, doesn't help you. You're looking for diversification. Or if you're looking for something that's got a combination of cash, bonds, property shares. Then you're looking at the multi-asset that Chris has been speaking about, so you can filter out very quickly the investments that are not appropriate for you. And then you can kind of narrow down.
Speaker 2:And my suggestion always is start with the cost. Once you've got a narrow selection and you've got 15 different things, you can choose immediately, cut out the five most expensive ones and focus on the next batch and then understand what's going on inside them and make sure that what they say on the box is being delivered inside the investment. That's the transparency that Chris mentioned. But you can make this a lot more simple quite quickly and don't be put off because there's so much to do at the beginning.
Speaker 2:And then, lastly, I think, focus on ease of use. It's one of those things where, if you're spending hundreds of hours managing five different platforms and the like, trying to understand that you've got one ETF on one platform in the US and another one on another platform in the UK, et cetera, et cetera, very quickly you're going to get to a position where you don't actually know what you own anymore and you don't know what proportion of your assets are in shares and what proportions in bonds et cetera. So make sure that you kind of limit your admin hassles to one or two platforms, not five, and very often you get some kind of a benefit of scale as well, where the more you have, very often you get lower transaction costs or just ease of use will save you a lot into the future. So that's me babbling on Chris, giving you some time for your answer.
Speaker 3:So I think I mean it's an interesting one. I was trying to throw back to my early days when I first entered the sort of financial services industry and we had investor clubs and all these kind of things. I think curiosity and experimentation is critical to understanding. You know industry and we had investor clubs and all these kinds of things. I think you know curiosity and experimentation is critical to understanding you know, what everything's all about.
Speaker 3:And then investing, I think, is critical. So you know, just make sure that it's appropriately sized when you experiment and when you want to do your work. There's no better way, for example, to find out what an ETF is all about than to actually go and buy one and, even if it's a few hundred grand, buy it, experience it. See. Oh wow, I just invested in like a you know, I don't know a racy tech ETF and I lost my shirt. That's a good life lesson. You know you want to learn that early and understand the benefits of diversification.
Speaker 3:But with that comes a healthy dosage of accountability, self-accountability.
Speaker 3:So you know, if you are going to experiment and learn because I think that's often the best way is just to dip your toe in the water and and and play and have fun and enjoy it um, then definitely hold yourself accountable, because at the end you want to retire with some money and you can't experiment for 40 years and find out that that's cost you your retirement. So I think, you know, some of my earliest learnings were through our investor club, where we, you know, had large small cap exposures in our portfolio and, you know, lost money or made money. And then the real benefit there was going back holding ourselves accountable after the year and said we feel like rock stars because we made this investment. But actually, if we stack it all up and we weigh our performance and measure our performance, it wasn't that great. So you know, you do have to behaviorally check yourself when it comes to investing, and so I think that you know I would encourage that that's certainly a nice way to learn sort of on the fly and enjoy yourself.
Speaker 2:I think it's a powerful lesson when you make a mistake, don't be too hard on yourself. If you've made a small mistake, ie with a small amount of money, then use it as school fees. Learn from it, go back and understand why you bought it and why it didn't work out. And when you get outrageous success with a small amount of money, be humble, because you have to acknowledge the role of luck in investments. Always, you know, and sometimes luck works for you and sometimes it works against you. But if you were lucky enough to buy something that doubled in a year, I'm sorry to say you're not a genius. You were lucky and you know you've got five years worth of return in one year, and well done. You were lucky and you know you've got five years worth of return in one year, and well done. It's great. But don't believe now that you walk on water in the investment sense, because you know markets have a funny way of humbling us very quickly.
Speaker 3:Exactly right.
Speaker 2:Chris Rule from 10X Investments, thanks so much for joining us. The time flew by and I actually learned quite a bit again as usual, chatting to you, and I appreciate learned quite a bit again as usual chatting to you, and I appreciate you sharing your information with us.
Speaker 3:Thank you, Warren. It was lovely to chat again and to touch base with you.
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