SMSFundamentals | Dec 12 2012
SMSFundamentals is an ongoing feature series dedicated to providing SMSFs (smurfs) with valuable news, investment ideas and services, in line with SMSF requirements and obligations.
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By Greg Peel
The switch of focus away from risk-based capital gain towards yield-based investments in the wake of the GFC sees no sign of abating, particularly as the safe haven of term deposits gradually loses its lustre through the RBA easing cycle. Over the same period, the number of ASX-listed exchange-traded fund (EFT) offerings has been growing steadily.
From humble beginnings, the number and variety of EFT listings have grown quickly in recent years to include currency, commodity and fixed interest products alongside equity index funds, sector-specific, REIT, international and “strategy-focused” equity funds. The latter group includes no less than four targeted “high yield” funds from four separate sponsors – iShares, Russell, SPDR and Vanguard.
A full list of ASX-listed ETFs can be found here.
The benefit of ETFs is that they remove the need for less experienced or less confident investors to “stock pick” and build portfolios accordingly. They are a boon for the passive manager, they reduce transaction costs, and can be useful within any wider investment portfolio. Were one simply looking to buy “the Australian stock market” for example, without being discerning nor wishing to be, one can simply buy an ASX 200 ETF and the manager will do all the hard work while providing seamless buy/sell opportunity in exchange hours.
Want exposure only to the Aussie banks? Then a Financials sector ETF may be the easy option. Want to invest only in solid dividend-paying companies to provide income (a necessity for retirees)? Then high-yield ETFs alleviate the difficult selection process.
However, investors need to be fully aware that “high yield” is not just a stroll-in-the-park, low-risk strategy promising a reliable income stream. Very high yields on offer often signal trouble, including the distinct possibility of a dividend cut and/or share price depreciation. This year has seen a few high-yield high flyers land back on earth with a crunch, while much sought after and reliable dividend payers have seen their stock prices pushed to beyond consensus fair value, thus diminishing the yield on offer.
Investors need appreciate that when one buys a stock offering a dividend, the yield on offer at the entry price is “locked in” unless the company's dividend policy changes. Subsequent share price movements do not affect the entry yield, but they will come home to roost as capital gains/losses once the stock is sold.
While ETF portfolio managers may have greater experience, access to research and pooled fund “clout” than Joe Investor, they are still human and have to make investment decisions based on best endeavours. There would be no market if all the players were in full agreement, thus it follows that the four high-yield ETFs listed on the ASX show little homogeneity.
"It is essential for investors to understand that ETFs are not all the same,” warns Michael Elsworth, Lonsec's general manager of specialised research, “and even high yield ETFs have different asset classes or sectors underpinning the investment. It is important to appreciate the different rules governing the construction of each index."
The point is that all four high-yield ETFs are fluid, with the underlying investment portfolio being actively managed in an attempt to provide the manager's perceived best result. Were one to take a snap shot of each ETF portfolio at a given point in time, the underlying high-yield portfolios would most often look very different despite all having a largely homogenous objective.
For example, Elsworth noted in a recent “snap shot” that the Russell, SPDR and Vanguard ETFs all had in excess of 40% exposure to the Financials ex-Property Trusts sector, which implies a heavy weighting towards the big banks. Not that there's anything much wrong with that at present, although ETF investors should be aware in case they already have bank exposure in their wider portfolio. On the other hand, the iShares ETF was distinctly different to the other three, with by far the least exposure to the financials sector.
The iShares ETF caps the underlying portfolio's exposure to individual sectors at 20% – lower than the other three – which provides for a high-yield fund that offers greater diversification and greater exposure to small-cap stocks.
Banks, diversification, small caps…which is most suitable for the individual SMSF trustee? Well that's for each trustee to determine for his or herself. You are not “self managed” for nothing.
The point is that research is a very important part of self-management, and the under-informed investor is the investor most likely to be disappointed. ETFs, high-yield or otherwise, can be valuable products but are not a panacea in the difficult world of investment.
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