ETF Exchange Traded Funds (ETFs) 2015

Ok, a thread for ETFs.

Lets start with Wikipedia ; https://en.wikipedia.org/wiki/Exchange-traded_fund

When people are talking ETFs in Australia, they are mostly talking about funds that track market cap weighted indices, typically STW (ASX200 tracker) or VAS (ASX300 tracker). Some might remember in Jan Somers books about how (and I paraphrase) it was not possible to for stock investors to closely track an index as the transaction costs were so high, so its pointless to compare property performance to stock index performance. Well, since Jack Bogle started Vanguard in the early 1970s in the states, it has indeed been very simple and cheap to do so. From unlisted index funds (which still exist, and are available in Australia through Vanguard and Realindex) the market has moved largely on to listed index funds ; "Exchange traded funds".

ETFs always trade at (or extremely close) to their net tangible assets, and typically have a very low fee basis. (VAS is 0.15%). Like a LIC, an ETF share represents a basket of stocks, but this basket of stocks is not chosen by a manager, but follows the index weighting. ie. say for example Company A was the 8th largest stock on the ASX, representing 5.575% of the ASX200 total market cap. Well, the ASX200 tracking ETF (STW) will hold that stock in exactly index weight, ie. it will be the ETFs 8th largest holding, and 5.575% of the funds assets. (its not exactly how it works but good enough to paint the picture )

Shareholders in ETFs, like LIC's benefit from capital growth in the form of share price appreciation of the underlying holdings which is reflected in the share price, and income, in the form of dividends from the underlying holdings. A difference here is that LICs will pay fully franked dividends, where ETFs will pass through dividends at the franking level received (often 70-80% franked).

ETFs are largely passive vehicles, so investors rely on efficient market hypothesis (perhaps for another thread). Though it is possible to take sector, or regional tilts, and there are now "Smart beta" ETFs that employ different quantitative methodology to create their own indices to track (ie. RAFI, Value, High Yield indices) which will interest some investors.

I am going to link Vanguard Australia as I think they do a really good job of providing basic education on Index investing and ETFs ;

https://www.vanguardinvestments.com.au/retail/ret/education/inv-library/intro-to-indexing.jsp

Ok, go for your life guys....trust this will be a useful thread

 

Great stuff Falcon! Look forward to learning heaps!

 

Excellent work Falcon! Thanks for stripping out all the noise and making the message crystal clear.

 

Let's note ETFs listed on the ASX can provide an exposure to Australian stocks - like the examples Falcon has provided - but can also provide exposure to international stocks such as US stocks, Emerging markets, or some kind of combination. These options exist either with exposure to the exchange rate or hedged. Vanguard has excellent options in this regard.

 

Spot on Ouga. Then there are sector specific...banks, resources, consumer staples, pharma, commodities etc

Market cap sizes, small caps, mid cap, small-mid, asx20 etc.

Then fundamental indices...value, quality, RAFI fundamental, equal weight etc.

All available on the ASX so you can splice and dice to your hearts content.

 

Falcon,

I appreciate your interest in sharemarkets, and have enjoyed reading your posting history. Your respect for Peter Thornhill is certainly well placed, and his appearances on Switzer's show have been great to watch. One question I have relates to leverageability (Peter Thornhill has been quoted as indicating he uses approximately 25% leverage).

Do you perceive a margin loan as the best tool for leveraging an investment in, say, VHY.ASX? The below link demonstrates to me how expensive this tool can be (at over 7%), even in this currently low interest rate environment.

http://www.leveraged.com.au/interest_rates/interest_rate_schedule.asp

Your thoughts would be appreciated.

Cheers
Greg

 

Thanks Falcon

ETF's are a growing market with some wildly varied types beyond the bread and butter index trackers i.e.. someone sees an opportunity based on investor sentiment to have a Japanese ethical ETF and bang, there you go, some financial company starts one.

With the ETF's and LIC's I found the below interesting from Switzer (though I think I've read it elsewhere also).

 

Hi Greg, allow me to reply in some detail later, it's a good question and and I will cover off some related things in my reply.

 

Yes spot on both points, the attachent is part of the reason why you will see lower yield percentage but full franking.

 

Cheers Falcon.

I am a very experienced trader, and am looking to complement this with a passive component, similar to my property portfolio. Purchasing, say VHY.ASX, outright with cash is however not a great avenue in my book for great returns. Paying > 7% for a margin loan is not outstanding either. Therein lies the challenge ....

 

There are couple of really good book on ETF's for anyone interested on the fundementals


The Australian ETF guide - David Bassanese
Exchange Traded Funs for Dummies - Russell Wild - although American the fundementals are the same. Some of the American ETF's can be traded on ASX.

A word of caution, the ETF market is growing all the time and some of the newer products, mostly not available on ASX, are moving away from the original simple idea of an ETF being an index tracker. If you are going to invest be sure you know what you are purchasing and the risks involved. Those types of product will probably arrive on ASX at some point, assuming ASIC (the government body who has to approve these things) is ok with them.

 

Just looked this up. $50 for an ebook seems a little steep. Do you think the price is justified?

 

IB offers a margin loan of 150bp over the cash rate for small amounts - ie currently 3.5%. I would suggest that is only for v. experienced traders who fully understand the extreme risks. You will also need the correct structure. It differs from a margin loan is a few ways - a significant one is that they can liquidate almost at their discretion - whereas a 'normal' margin loan gives you a few hours to improve your position.

The rate comes down to 2.5% for over A$1M

 

good info! Thanks Falcon!

 

I don't remember paying that much. Just checked, I paid $3.99 on Amazon - it said it was a sample but I actually got the whole book. No idea if that problem has been fixed.

It's the only book I've found that specifically deals with ASX listed ETF's.

It's not a very long book. However if one is potentially going to invest 1000's into ETF's then $50 does not seem so much.
I guess given it's a niche book David is only going to make a reasonable profit with a higher price.

 

Greg, seeing you have a property portfolio how about using non callable (loc) debt?

Failing that, (or in addition to) I agree 7% is way too high and not viable except for trading. Westpac has 5% available for small balances, CHESS sponsored too, none of this interactive brokers rubbish. Obviously interest rates are very important, particularly if being used as part of a long term dollar cost averaging strategy. I've got 4.10% at the moment, but that is not a small facility.

Another way to use is just have a margin loan queued up for an extremely rainy day....then it's just a matter of having the conviction to push the button, when the sky is falling.

Now to your question of leverage levels on callable debt (margin loan) yeah Peter Thornhill may be a touch conservative, but not by much. My view, is ideally around 33% as a relatively safe level, up to 40%. Above that you'd want to have a pretty clear plan of how you will respond to margin calls and the ability to meet them Regardless, you should always have a plan anyway, there is no fixed rule here, except less is more (debt - sleep ratio).

The key here is making sure you don't get shaken from the tree, it's a long game!

Some might find this of interest;
http://www.econ.yale.edu/~af227/pdf/Buffett's Alpha - Frazzini, Kabiller and Pedersen.pdf

I'd also have a think about whether VHY in the current yield chasing environment is the ideal vehicle. I'm not saying it's not, but I'd consider it carefully. Cheers.

 

Falcon

A very insightful and comprehensive reply - you clearly have "skin in the game", hence my interest in your thoughts.

Concur on Interactive Brokers - I have trialled this, but hated the interface, and all of the superfluous complexity. So yes, not for me either.

LOC - now exhausted on a rather large property portfolio, grossing approximately 100k per annum. So, the LOC has been well used, and is not an option for the (short-term) time being.

"A margin loan queued up for an extremely rainy day" - I already have this option, via trading and with easily obtainable, low cost leverage, but perhaps not suited to very long term holds.

Thanks for that linked paper - I had read it before, but it was valuable to re-read and reiterate the key concepts. I think the following paragraph worthy of a copy/paste:

"...In essence, we find that the secret to Buffett’s success is his preference for cheap,
safe, high-quality stocks combined with his consistent use of leverage to magnify returns
while surviving the inevitable large absolute and relative drawdowns this entails. Indeed,
we find that stocks with the characteristics favored by Buffett have done well in general,
that Buffett applies about 1.6-to-1 leverage financed partly using insurance float with a
low financing rate, and that leveraging safe stocks can largely explain Buffett’s
performance..."

Your view on optimal levels of callable debt is insightful. Having primarily traded short-term instruments and time periods, it is a topic at the forefront of my mind. Your thoughts of 33-40% being the sweet spot will provide further food for thought.

VHY - this was only used by way of example, as numerous Somersofters had opined on it in the original forum. Looking at its chart, it appears quite illiquid, though for a very long-term hold, this is probably not a major concern. And don't worry, Falcon, the due diligence will be surgical prior to any action.

Again, thanks sincerely for your thinking.

Cheers
Greg

 

Thanks for sharing the PDF link.

Could LICs be considered safe stocks?

Fingers crossed the answer is yes as I've been using equity draws to purchase LICs to add to my buy-never-sell portfolio to provide for my retirement income stream.

 

You are all over it. Keep us posted as to what you end up doing

 

Well with traditional LICs you have a pretty good basket of stocks, low fees, Conservative management that won't do anything crazy. My view is that traditional LICs are about as safe as it gets for buy and hold and for most people optimal for what you are doing. I don't consider volatility as risk, but risk of permanent loss off capital. In that regard, risk is very low. I think you are good