Warren Buffett is a strong advocate of investing in a broad market index, and ETFs are typically the cheapest way of buying an index. Other ways include buying mutual funds that track the index or, specifically popular in our country, UITFs that track the same benchmark.
While there are hundreds of Mutual Funds and UITFs, with several of them tracking the PSEi, we have but one ETF. Why aren’t there more ETFs that track the Philippine Stock Exchange Composite Index (PSEi), the Philippines’ broad market index?
What are ETFs?
ETFs, or “exchange-traded funds,” are pooled funds designed to track a benchmark like the PSEi. Like Mutual Funds and UITFs, ETFs may be designed to track different benchmarks. There are ETFs that track specific asset classes such as equity or bonds, and there are ETFs that track specific industries such as real estate or cloud computing.
But unlike Mutual Funds and UITFs, ETFs are bought and sold on an exchange like the PSE. They trade like other stocks in the stock market, making liquidity a strong point.
Why are ETFs cheaper?
There are fewer costs to run a passively-managed ETF, and this means fewer fees are passed on to investors.
A major reason for the reduced costs is the way it is bought and sold — the fund isn’t involved in every buy and sell transaction. It is traded like other stocks in the stock market, so the fund doesn’t incur unnecessary administrative costs handling its buy and sell orders. Another reason is it merely copies what’s on the index, and there’s no need for expensive research analysts. This isn’t the case with “enhanced” index funds by Mutual Funds or UITFs. There are also no commissions paid out to selling ETFs.
For example, FMETF’s management fee, the sole ETF in the Philippines, is 0.5% of its total assets under management. While this rate is comparatively higher than its peers in the global market, this is still a lot lower than similar Mutual Funds and UITFs with management fees from 0.75% to 1.5%.
What do lower costs mean to the investor?
The differences in fees might not seem much. But equity funds target long-term investors, and these differences compound significantly over time.
The exact differences will vary based on the expected returns, but we’ll consider this example for simplicity: 1 million pesos invested now with annual returns of 10% over a 10-year period. If we assumed management fees of 0.5% and 1% for ETFs and Mutual Funds/UITFs, respectively, then the difference in ending values would’ve been around 250,000 pesos.
Besides, with the availability of a cheaper option, there’s little reason to go for the expensive ones, even in shorter time periods.
I imagine how the introduction of more ETFs can reduce the costs of competing products like Mutual Funds, UITFs, or other ETFs. They will all compete on price, and that’s a win for investors. A win for investors is a win for economic growth, and ultimately back to fund managers and investors — a reinforcing loop.
This is written from the perspective of an outsider, and there may be ETF-specific challenges to fund managers that I am not aware of. I’m sure there are. Fund managers, hit me up!
Bio: Dan Dima-ala is a 2-time real estate board exam top-notcher, real estate investor, entrepreneur, and former corporate finance professional. He has a degree in economics & finance and is a certified Accounting & Finance Mentor for GoNegosyo. As a financial freedom advocate, Dan shares his unique insights at freedom locker PH.