The benefits of investing in exchange-traded funds (ETFs)

What are ETFs and why is it beneficial to buy them?

Personal Investing - By Ooi Kok Hwa

LATELY, the number of ETFs that get listed on Bursa Malaysia has been increasing.

At present, we have a total of five ETFs listed in Malaysia. Unfortunately, we have noticed that not many investors are aware of these instruments and there is also a lack of understanding on the true value of these ETFs.

ETF stands for exchange-traded fund. Buying into ETFs is almost similar to buying normal mutual funds. The key differences are that investors can buy or sell ETFs in a stock exchange or go through an authorised participant whereas investors can only buy and sell mutual funds through unit trust companies or other financial institutions.

ETF originated in United States. During 1960s and 1970s, some fund managers in the US discovered that it was quite difficult to beat the stock market index. They discovered that it was better to buy stocks that mirrored the index composition as many fund managers found that they tend to underperform the index.

As a result, the ETF industry has been growing in the US from two ETFs in 1995 to more than 900 ETFs listed in the US now. At present, there are many types of ETFs available in the US, for example ETFs on stocks, bonds, commodities, currencies and countries. For stocks, ETFs can be further divided into different types of market capitalisation (big cap vs small cap), equity styles (growth investing vs value investing) as well as different types of sector funds (like ETF on stocks in technology, health care or financial institution sectors).

One of the key advantages of buying into ETFs is that it is cheaper to buy ETFs as compared to normal mutual funds. Investors need to pay about a 5.5% sale charge (also known as front-end load) for normal mutual funds whereas they only need to pay a normal brokearge fee of 0.7% (inclusive of all other charges) for ETFs.

Comparing similar type of funds, the annual management fee for ETFs is generally lower than that of mutual funds.

Normally, ETF will charge about 0.65% per annum (0.6% for the annual management fee and 0.05% for the index license fee).

However, normal mutual funds will charge about 1.5% annual management fee. Assuming an investor intends to buy an index fund and intends to hold the fund for a one-year period, he or she will incur about 1.35% (0.7% - total transaction fee and 0.65% - annual management fee and index license fee).

However, the investor will incur about 7% (5.5% for sale charges and 1.5% for annual management fee) if he buys into the normal mutual funds. Given that ETFs are using the “in-kind” creation and redemption of shares, they eliminate any price discrepancy to net asset value (NAV) due to the supply and demand pressure.

As compared with close-end funds where investors may buy at the premium or discount to its NAV, the price that we pay for ETFs will be closed to its NAV like the normal mutual funds. As an added advantage over mutual funds, ETFs are generally more liquid than normal mutual funds as we can buy and sell them through secondary markets.

Please refer the chart for the mechanism of creating an ETF. The reverse of all of the arrows will be for the redemption of an ETF.

In addition, ETFs provide investors the benefits of portfolio diversification, same as normal mutual funds. Given that they will try to replicate the benchmark indices, their performances will be very close to the indices.

In Malaysia, sometimes we notice that some mutual funds may underperform their benchmark indices.
In short, we believe that there will be more ETFs getting listed on the stock market.
It will be to investors’ benefit to understandhow they can add ETFs onto their investment portfolios as a cost effective investment alternative.

Ooi Kok Hwa is an investment adviser and managing partner of MRR Consulting 

Investing Advice: 5 Benefits of ETFs

Understanding the strengths and weaknesses of your investment options is fundamental to successful investing. Advice may be limited to how it fits into your particular investment strategy, but ETFs offer an opportunity to diversify without starting out with a great deal of money. Here are the five strengths of investing in ETFs.

When people ask for investing advice, ETFs usually come up pretty quickly, because they are so heavily marketed and trumped by the industry. Exchange-traded funds, or ETFs, are an easy way to diversify a small investment, but to get the most out of your investment, it is important to understand how they operate.

ETFs are like mutual funds, in that they are a collection of investments, but they are traded on an exchange, such as the NYSE, instead of purchased directly from the issuing company. They also differ in their redemption structure and tax efficiency from traditional mutual funds.

Here are five benefits of ETFs over mutual funds:

1. Tax Efficiency: Upon redemption, mutual funds must sell its underlying securities, and the capital gains are then distributed to the owners of the funds. Since ETFs trade on an exchange and investors are selling to other investors, no underlying securities are sold, and no capital gains are distributed. If the makeup of the ETF changes it will, occasionally have to distribute gains, but it should be less frequent than with traditional mutual funds.

2. Lower Fees: ETFs are no-load funds, and you won't be slapped with a redemption fee when it's time to liquidate your position. Further, ETFs typically have lower annual fees than traditional Mutual Funds, making them an attractive alternative. (NOTE: In rare cases where a very small amount is being traded, broker's fees may be a higher percentage of the investment than a mutual fund's expenses would be, but in most of these cases the invested amount would not meet the minimum investment required by most mutual funds).

3. Liquidity: The exchange-traded structure of ETFs generally allow for liquidation of a position faster than a mutual fund, which must be liquidated at end of day. Further, the ability to set a limit order allows flexible trading that no investor could get from a mutual fund. Not all ETFs have the same liquidity, however, and it is important to review trading volumes and the ETF prospectus to determine whether you are comfortable with the frequency of trades.

4. Intraday Pricing: Because ETFs are traded on active stock exchanges, purchases and sales happen at market prices, rather than end-of-day Net Asset Value, which mutual funds use. As a result, one may purchase ETFs at a premium or a discount to the value of the underlying assets, and arbitrage is frequent.

5. No Minimum Investment: When starting investing, diversification can be cost prohibitive if you're using traditional mutual funds, which frequently have a minimum investment of $2500 or more. Because ETFs have no minimum investment (other than the market price of one share), they are a good vehicle for diversified investing.

Of course, many of these benefits could be liabilities if not used properly. For instance, the intraday pricing feature of ETFs could lead an investor to buy an ETF at a premium or sell it at a discount to the value of the underlying securities. Also, brokerage fees may have a greater impact on some investors than traditional mutual funds' management fees and loads would have.

Used wisely, ETFs can be a good vehicle for widely diversifying a small or initial investment, but it is always best to seek professional investing advice.

In the future I will cover the five negatives of investing in ETFs.

By Pat Regan

An exchange-traded fund (ETF), a member of exchange-traded product-family (ETP), is an investment fund traded on stock exchanges, much like stocks.^[1] An ETF holds assets such as stocks, commodities, or bonds and trades at approximately the same price as the net asset value of its underlying assets over the course of the trading day. Most ETFs track an index, such as the S&P 500 or MSCI EAFE. ETFs may be attractive as investments because of their low costs, tax efficiency, and stock-like features.^[2][3]

Only so-called authorized participants (typically, large institutional investors) actually buy or sell shares of an ETF directly from/to the fund manager, and then only in creation units, large blocks of tens of thousands of ETF shares, which are usually exchanged in-kind with baskets of the underlying securities. Authorized participants may wish to invest in the ETF shares long-term, but usually act as market makers on the open market, using their ability to exchange creation units with their underlying securities to provide liquidity of the ETF shares and help ensure that their intraday market price approximates to the net asset value of the underlying assets.^[4] Other investors, such as individuals using a retail broker, trade ETF shares on this secondary market.

An ETF combines the valuation feature of a mutual fund or unit investment trust, which can be bought or sold at the end of each trading day for its net asset value, with the tradability feature of a closed-end fund, which trades throughout the trading day at prices that may be more or less than its net asset value. Closed-end funds are not considered to be "ETFs", even though they are funds and are traded on an exchange. ETFs have been available in the US since 1993 and in Europe since 1999. In 1993, the first country specific ETFs were a collaboration between MSCI, BGI and a small independent third party Distribution firm called Funds Distributor, Inc. The product eventually evolved into the iShares brand widely known around the globe. ETFs traditionally have been index funds, but in 2008 the U.S. Securities and Exchange Commission began to authorize the creation of actively managed ETFs.^[4]

Contents

• 1 Structure
• 2 History
• 3 Investment uses
• 4 Types of ETFs
  
  • 4.1 Index ETFs
  • 4.2 Commodity ETFs or ETCs
  • 4.3 Bond ETFs
  • 4.4 Currency ETFs or ETCs
  • 4.5 Actively managed ETFs
  • 4.6 Exchange-traded grantor trusts
  • 4.7 Leveraged ETFs
• 5 ETFs compared to mutual funds
  
  • 5.1 Costs
  • 5.2 Taxation
  • 5.3 Trading
• 6 Criticism
• 7 Issuers of ETFs
• 8 See also
• 9 References
• 10 Further reading
• 11 External links

China: a developing nation with growing pains

Though 61 is a mature age for people, the new China, which celebrated the 61st anniversary of its founding on Oct. 1, is still in its adolescence, developing rapidly and full of the vigor of a young man.

Also like a youth, the country has experienced growing pains over those contradictions between its self-perception and recognition by its peers.

China has been on track for rapid development during the three decades since its reform and opening-up in the late 1970s, as gross domestic product (GDP) jumped to more than 34 trillion yuan (5.08 trillion U.S. dollars) in 2009, from 364.52 billion yuan in 1978.

Even the global financial crisis failed to slow the country's developing momentum, with an annual growth rate of 9.1 percent last year, outshining its developed counterparts, such as the U.S. and Japan.

Despite the impact from the economic downturn, China also replaced Germany as the world's third largest economy and largest exporter last year, and overtook the U.S. to become the world's largest auto market.

What's more, in the second quarter of this year, China's GDP exceeded that of Japan for the first time.

Zhuang Jian, chief economist with the Asian Development Bank, praised the achievements China has accomplished during the past three decades, saying its strong growth has boosted the confidence of the Chinese people and encouraged them to work harder for a better future.

As China's economic clout grows, so do suspicions, criticism and even intentional exaggerations. Different readings on China's development have caused confusion - is China still a developing nation or a developed one?

The Chinese government has reiterated its status as a developing nation, while some insisted that China could no longer be called an emerging economy, and thus held China accountable for more responsibilities in its trade surplus, exchange rate, emission reductions and energy consumption. There is also fear that the emerging China would be a threat to other nations.

Premier Wen Jiabao said in September at the UN General Assembly that China was still in the "primary stage of socialism" and remains a developing country.

"These are our basic national conditions. This is the real China," he said.

Wen stressed this point with data showing that, although China's GDP ranks it as the world's third largest economy, per capita GDP is only one-tenth of those of advanced countries. China's further development is constrained by its shortage of resources, as well as energy and environmental problems, he added.

Experts believe that the growing Chinese economy is too large to be ignored, despite it still being a developing economy.

Wang Jun, a researcher with the China Center for International Economic Exchanges, said China would continue its relatively fast economic growth for an extended time, a fact that would be difficult for some nations to accept in the short term. This also requires constant adjustments in how China views its own development, as well as how other nations see China, he said.

"Misunderstandings and conflicts are inevitable," Wang noted.

"I can't name another country in the world that has changed so much in so short a time," said Patrick Chovanec, an associate professor at Tsinghua University's School of Economics and Management in Beijing. He has been coming to China since 1986.

Chovanec noted that China has undergone one of the most rapid and dramatic social changes in history, and "it is still playing out".

"People around the world have a lot of uncertainty over what a more powerful China would look like and what it would mean for them. A lot of cultural and political differences remain, and some of them are pretty significant," said Chovanec. So it is understandable that people have some fears and concerns, he added.

Further, to deal with misjudgments, Zhuang Jian said China should be more involved in explaining its true self to the world as it becomes more involved in the international community.

Patrick Chovanec suggested China should "try to empathize, and develop a thick skin ... As it becomes more powerful, China is going to be on the receiving end of more, not less, criticism. "

Sheng Hong, director of the Beijing-based Unirule Institute of Economics, warned of self-complacency and arrogance, saying the larger one's economy grows, the more cautious and humble it should become.

"China should take some criticism seriously, apart from that criticism based upon purposely harmful intentions, which could help step up its economic and political reform. Also, a clear understanding of its real strength would help the government to make the right decisions," he said.

Zhuang Jian said China's strong economic growth, mainly fueled by its large investment of resources and capital, is unsustainable, inefficient and energy-consuming, remaining vulnerable to the changes of the outside world.

China has a long way to go to catch up with the developed nations in terms of per capita GDP, and China is lagging far behind in terms of industrialization, Wang Jun said.

The biggest challenge that China will face in this century is how to achieve sustainable development, he said, adding that the imbalance of regional development, income disparities and the widening gap between state-owned and private firms are also among the difficulties China must face during its future development.

Additionally, Sheng Hong said China has to step up its reforms in becoming a market economy to achieve sustainable development. For the achievements China has gained have been attributed to economic reforms, because of which millions of Chinese workers can now unleash their creativity, rather than only their hands.

China should also accelerate political reforms, including restraining and effectively supervising its administrative power to match the economic reforms, said Sheng.

Source: Xinhua

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Can You Make It as an Entrepreneur?

By Eve Tahmincioglu of Entrepreneur.com

The recession has inspired many long-time employees -- ravaged by downsizing, furloughing and a host of other corporate cutbacks -- to consider going out on their own.

While it can be tempting, especially if you think you have a killer business concept, you have to ask yourself, "Am I cut out for entrepreneurship?"

"Everybody's got a great idea, but that doesn't mean it's going to work," says Vince Orza, dean of the Meinders School of Business at Oklahoma City University and an advisor to the university's Love's Entrepreneurship Center.

The successful entrepreneur, he adds, has a deep-seated passion for being his or her own boss. "It's that kid with a lemonade stand, the kid with the paper route," he explains. "If early in life you had that bug, you're more inclined to have it later in life."

I've interviewed hundreds of business owners in my work writing about small business, and there are a few common characteristics and personality traits most of them have:

• They tend to be risk-takers. (Not bungee-jumping-type risk-takers per se, but fearless when it comes to pursuing what they're passionate about.)
• Many had a burning desire from a young age to run their own businesses.
• Most are embarrassed of failure but not afraid of it.
• Multitasking seems to come naturally.
• Their work-ethic-o-meter is often off the charts.
• Most are confident beyond what would seem reasonable.

If this doesn't describe you, it doesn't mean you can't try your hand at self-employment, but entrepreneurial experts predict you'll be swimming upstream without at least a few of these at your core.

Scott Kluth, founder of Chicago-based CouponCabin.com, ran a lawn and snow service when he was 11 years old and brought in about $350 a week.

"If you asked my mom, she'd say I was an entrepreneur since birth," says Kluth, whose online coupon service brings in about $13 million in annual revenues and employs 38 people.

He worked for Sears.com before launching his own company in 2003. What motivated him was a burning desire to have control over his own destiny. "I wanted to be focusing on my own success," he maintains.

Allison O'Kelly, founder of Atlanta-based Mom Corps, also had a dream to run her own business from a young age, but found a successful career as an accountant for the audit and tax advisory firm KPMG before becoming an executive with Toys "R" Us. Her desire for more flexibility after her sons were born pushed her to finally pursue entrepreneurship.

O'Kelly describes herself as a risk-taker who is ultra-confident, especially when it comes to the business model for Mom Corps, a staffing company focused on getting moms part-time work. The company has 10 employees and annual sales of about $2 million.

"I was confident in my skills and what I had to offer," she explains. "I always had the attitude that I could do this. I'm very positive about what I do. I never believe I can't do something. That's what makes me successful."

While she admits there were times early on in her business when she was spending too much on things such as salary and marketing, and came pretty close to seeing her venture go under, she was able to persevere.

"I would be stupid to think there is no way I could ever fail, but that's what I tried to tell myself," she recalls. "I was going to do everything in my power not to fail because I would be embarrassed if I failed."

Another attribute that great entrepreneurs possess is a commitment to a vision for a product or service they believe in, according to Deborah Bailey, author of "Think Like an Entrepreneur: Transforming Your Career and Taking Charge of Your Life."

"They can see the possibilities that others can't, and because of that they may not get support or agreement from others around them," she says. "Focusing on your vision will help keep you on track and keep you motivated through the ups and downs."

Indeed, that's the double-edged sword for many entrepreneurs: The blind commitment that drives them can also lead to stunning failures. But a true entrepreneur, says Oklahoma City University's Orza, gets up and starts all over again.

So, do you think you have what it takes to make it as an entrepreneur?

Mom Corps' O'Kelly maintains, "If you're asking yourself the question, 'How do I know?' then you shouldn't do it."

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