Exchange traded funds launched on the NSX

In mid-September, a number of new products were launched on the Namibian Stock Exchange in the form of commodity ETFs. What are ETFs and how does their appearance on the NSX affect investors?

ETFs, or Exchange Traded Funds, are securities that comprise of a portfolio of other securities designed to mirror a specific market index, commodity or sector, much like other collective investment schemes such as mutual funds or unit trusts with tracker mandates. The primary difference between ETFs and these collective investment schemes is that the former are traded like stocks on an exchange, while the latter are usually over-the-counter (OTC). The ETF itself is priced intraday off the underlying portfolio assets, which are priced through normal supply-demand dynamics within the market. Theoretically, abnormally strong demand for an ETF can move the price away from its underlying asset value, however given the transparency surrounding the makeup of an ETF, a short term price move away from the underlying asset value will trigger arbitrage players that will bring the two prices back inline.

ETFs are constructed for various purposes but most mirror market indices such as the JSE Top40 or S&P 500, or they mirror a specific sector of the market such as recourses or industrials. They are constructed by buying a basket of all the stocks or bonds in an index or sector -these are called creation units. The option of receiving the actual shares in the creation unit has positive tax implications for the fund and thus the holders of units in the fund. A large redemption from a mutual fund means that the fund has to sell some of its assets thus realising a profit or loss which is generally taxable. A large redemption from an ETF can be done by transferring the actual underlying securities. As this is a non cash transaction there is no capital or otherwise taxable gain incurred.

The ETFs listed on the NSX cover gold, platinum and palladium. The shares of each is backed 100% by the actual commodity which is held by the issuer. Thus a share in, for example, the NewGold ETF, represents a 1/100th of a troy ounce of gold. For every 100 shares issued, NewGold, as the issuer, holds a physical troy ounce of gold in a vault. The net effect is that investing in the ETF is the simplest way of investing directly in gold. It is also the cheapest way as costs, like insuring and managing the gold, are minimised due to the scale of the ETF. The passive nature of investing in a commodity means that these ETFs are cheap to manage. The most expensive of the ETFs on the NSX charges 0.4% per year in fees.

The price of an ETF will diverge from that of the underlying asset over time due to the decaying effect of management fees as illustrated by the diagram below. The price of an ETF starts as a fraction of the commodity price on the first day of trade (for example 1/100 troy ounce of gold). From this point a management fee is deducted daily causing the price to diverge from the price of the underlying commodity. Effectively, the claim of one share on the underlying asset is decayed. For this reason two ETFs with the same underlying assets but different inception dates or fee rates will have different market prices. Due to this decay, two similar ETFs are rarely comparable on price alone. The cumulative decay needs to be taken into account when comparing the current market prices of two similar ETFs to determine if one is cheap relative to the other. Thus an ETF with a higher price could be considered cheaper than one with a lower price as it has a greater claim on the underlying physical assets.

The value that ETFs bring to the NSX include easy, cost effective, exposure to gold and the platinum group metals, thus allowing wholesale and retail traders and investors convenient access and exposure to this new asset class on the exchange. Caution should be taken to select the correct ETF as with any security on the exchange. Underlying assets differ and one should look into which ETF offers the best exposure for a specific investment need. The inclusion of the new ETFs on the NSX is a positive step towards expanding the exchange and offering Namibians a wider range of investment options, and in our view, one step of many towards deepening the Namibian financial sector.

Current NSX listed ETF’s are as follows:

ETF List

Example: ETF price decay over the last 14 years calculated on a 0.4% management fee

ETF Decay Example

 

Bookmark the permalink.