A look at ETFs and Zero Certs

Eighteen ETFs are listed on the Singapore Exchange (SGX), the latest of which made its debut last month – the Lyxor India Nifty ETF 10, a diversified stock index that accounts for 21 sectors of the Indian economy, including chemicals, oil and gas, banks and technology. Others listed here include the CIMB FTSE Asean 40 ETF, iShares MSCI India ETF, ABF Singapore Bond Index Fund and StreetTRACKS Gold Shares.

Also operating on the same principle are participation certificates, which, like ETFs, track the performance of an underlying asset or index on a one-for-one basis. Those on SGX include the ABN Amro Indonesia Index Zero Cert, ABN Amro Pakistan Index Zero Cert, Dow Jones Euro STOXX50 Index Zero Cert and Kuala Lumpur Composite Index Zero Cert. This month, ABN Amro launched new certificates linked to the Rogers International Commodity Enhanced Index or RICI Enhanced, which comprises 37 listed commodities including energy, agriculture, industrial and precious metals.

‘The main difference between ETFs and Zero Certs is in the legal framework,’ explained Miles Ashton, ABN Amro’s head of sales and public distribution of private investor products in Asia. ‘For an ETF, the assets are segregated from the balance sheet of the issuer, so it’s a fund, whereas Zero Cert is a security issued by – in our case – ABN Amro.

‘The difference is that an investor buys a fund in one case and in the other, (he buys) ABN Amro paper that is linked to the performance of an underlying index.’

Another difference is that Zero Certs have a tenor or maturity period of three years, while ETFs are open-ended.

Shares in each ETF and Zero Certs can be bought and sold via a broker, like any equity. Investors will need two accounts: a trading account with a stockbroking member of SGX, and a securities account with the Central Depository. They can then buy or sell the instruments – which are traded intra-day and in board lots – through their broker or online trading account. Once issued, the price of an ETF or Zero Cert moves up and down in line with the target index.

Advantages and risks

One of the factors that make ETFs and Zero Certs attractive is that they are cheaper than unit trusts or mutual funds.

‘The costs are relatively similar for both (ETFs and certificates), which are much lower than actively-managed funds,’ said Mr Ashton. ‘If you buy a fund from your broker or consumer banker, for instance, it’s 3 to 5 per cent of upfront loading fees and management fees of 2 per cent per annum.’

Conversely, for an ETF, about 0.75 to 1.5 per cent per annum of asset is deducted from the investment daily, while for the Zero Cert, the issuer receives after-tax dividend of the index components.

Another factor is that both vehicles enable investors to get their foot into specific markets and asset classes, including shares of companies listed on overseas exchanges, thereby offering them diversification.

‘I see an ETF as an investment tool rather than an end-product. It helps investors build a customised portfolio,’ said Joseph Ho, managing director and head of ETFs in Asia at Lyxor, which has eight ETFs on SGX. Investors bullish on India, for instance, can allocate a percentage of their investment into the market through ETFs and reap returns should their view prove correct, he explained.

Mr Ashton said of certificates: ‘The platform can be summed up by saying it’s essentially like a supermarket for retail investors, where they can pick from a variety of different Zero Certs linked to investment themes and create their portfolios.’

However, the ETFs’ performance is directly affected by that of their underlying component stocks or bonds. The impact, however, is cushioned to some extent by diversification, as an ETF itself is a diverse pool of stocks or bonds.

Another risk to consider is the possibility of tracking errors. An ETF may sometimes not reflect the performance of its underlying index due to factors such as timing differences between countries.

‘When the ETF is not doing what it’s supposed to do, when you want it to give a return but it doesn’t replicate its benchmarked index, you’re in trouble,’ warned Mr Ho. ‘It’s something investors have to look out for.’

Bright future for the market

ETFs were first introduced in the US in 1993, and have grown to more than $250 billion today. And while Asia has only recently started playing catch-up to that, the products have been growing in popularity.

At an ETF conference in late February, Morgan Stanley managing director and head of investment strategy Deborah Fuhr said Asia ‘will see many more (ETF) products coming on the market and a lot of people using them here, as well as elsewhere’.

Mr Ashton has also seen ‘tremendous growth in this area already’, but noted that more education is needed for Asian investors to familiarise themselves with the products.

‘Here in Asia, the market is at the more junior stage compared with that in Europe,’ he said. ‘But I think it’s a matter of education and awareness-building, and investors will see that the track record of these rule-based certs or ETFs has outperformed active fund managers who charge a much steeper fee structure.’