ETFs - A Viable Option

Published: Wednesday July 16, 2008

Mutual Funds have been the hot topic on the lips of many investment companies in Jamaica as of late. The diversification of these funds is successful at combating inflationary pressures, and as we watch inflation soar to 9.4 per cent as of May this year, it is obvious why it has become a prime candidate for further investigation.

Nevertheless, instead of focusing all our might on mutual funds, why not look into Exchange-Traded Funds (ETFs) which can be a focused or diversified investment option?

So what is an ETF? An ETF, as previously stated, can be a focused or well-diversified investment vehicle that is used to track an index. It allows individuals to invest in areas not usually explored - for instance utilities, commodities, and foreign markets. ETFs are traded on stock exchanges and can be bought, bought on margin, sold, and sold short, much like a bond or a stock. Some ETFs also have future and option contracts, which give investors the option of risk management and hedging. Unlike its "cousin" the Mutual Fund, which at times only publishes its top 10 holdings at the portfolio manager's discretion (which is generally on a monthly or quarterly basis), all the holdings in an ETF's portfolio are completely transparent and investors can be advised on its activities daily.

Another upside to ETFs is that annual fees are as low as 0.09 per cent of assets, which is amazingly low compared to the average 1.4 per cent fee charged by mutual funds. One can argue that with ETFs investors are required to pay a brokerage fee to process their transactions, while mutual funds have no fee attached. However, there are no fees associated with trading ETFs besides the brokerage trade on the buy and sell side. Also, with ETFs there are discounts available, so this fee becomes insignificant with large trades. Since fees are ridiculously low and the fund is easily maintained, ETFs usually have a low expense ratio.

On the flipside of the coin, some investors and advisors simply don't take a liking towards ETFs. They are discouraged by the unknown portfolio methodologies and the overwhelming number of choices. However, when I think about a large number of options, I definitely don't consider it a bad thing. Also, a lot of ETFs are just benchmarks for a basket of stocks or securities. Therefore, investors do know what is in most of them once they read.

Hypothetically, if we were to create an ETF locally, companies such as Jamaica Public Service Ltd., Jamaica Broilers (Ethanol Division), and possibly the Bauxite and Alumina manufacturers are an idea. They could be a pooled together with others to create a diversified ETF in Jamaica.

ETFs have been in global demand in more developed markets, proving that the good outweighs the bad. They have been available in the US since 1993 and in Europe since 1999. They are well known for being the most innovative investment vehicle of the last two decades and it has fundamentally changed the way investment advisors construct portfolios. This type of fund fits right in line with the ideals of a buy-and-hold investor, as it is economical to buy and low maintenance over the long-run.

ETFs are a good addition to a portfolio especially in turbulent times. The present state of the global economy is a prime example, which has been greatly affected by unreasonably high oil prices. The flexibility of ETFs allows them to be "played with" in order to make higher returns in this volatile commodity market. Take for instance, The Energy Select Sector SPDR fund (XLE). This fund has increased almost 9 per cent year-to-date and improved over 27 per cent (yoy). UltraShort Oil and Gas (DUG) and Ultra Oil and Gas Proshares (DIG) are other ETFs that include oil and have proven to be very profitable investments. As we expect oil prices continue to climb, and so will the above ETFs.

Another ETF showing vast improvements despite the state of the global economy is the iShares Dow Jones Basic US Materials (IYM). It has moved up almost 12 per cent year-to-date and 23 per cent (yoy). This fund's portfolio comprises of companies spanning varying industries such as aluminum, commodities, precious metal and steel production. Steel prices have already seen an increase and will continue to rise, as a result of the construction boom in Dubai, India and other emerging markets. The overpriced iron ore contracts accepted by major steel manufacturers- Rio Tinto Group and more recently Nippon Steel Corp, is another factor driving the price.

So what does this mean for Jamaica? As we are moving towards a global market standard, we will eventually have to implement these developed financial instruments over time.

With high oil and food prices pushing instability in the Jamaican market, ETFs are something that should be take advantage of, sooner rather than later. In the meantime, investors should consider looking at IYM and DUG as current market conditions facilitate these funds to deliver promising returns over the medium.


Source: Jamaica Observer
http://www.jamaicaobserver.com/magazines/Business/html/20080715T210000-0500_137892_OBS_ETFS___A_VIABLE_OPTION.asp