As these product innovations happen, further innovations at an advice level will become possible. Effectively navigating this new order is going to be challenging for financial advisors.
ETPs: the new order
The Johannesburg Securities Exchange (JSE) has recently allowed the listing of a range of new exchange-traded products (ETPs). Individuals can now buy and sell portfolios through a single listed investment product across multiple asset classes.
This innovation has had two key effects: firstly, investors can now access via the JSE what used to be only available via mutual funds accessed through Linked Investment Services Providers (LISPs). Secondly, the range of investment opportunities available has also expanded rapidly. You can now get access to previously unavailable investments such as individual global stocks (eg Amazon or Alphabet), new indices (such as the Helios Space Index) and even actively managed diversified commodity funds (such as the one offered by Coherent Commodities in partnership with UBS). These choices were not available via the mutual fund channel, nor is it likely that they would be.
This range of additional choices brings opportunities to lower costs and increase solution customisation – but also brings complexity from an advice perspective. For active investors, ETPs offer the advantage of intra-day pricing and trading vs the daily price and trade settlement opportunity offered by mutual funds.
Exchange-traded Funds
These securities track the performance of a specified index such as a portfolio of shares, bonds or single commodities. According to the JSE, at the end of September, there were 98 exchange-traded funds (ETFs) worth about R136-billion. Some of the most popular examples include the NewGold and Top 40 ETFs.
The defining characteristic of an ETF is that the index (and thus the constituents) is defined in terms of a pre-defined set of rules reflecting a set of desired characteristics. As these rules are defined in advance and implemented mechanically, they are well-suited to investors who want the specific characteristics embodied in the index design at a cheap total cost.
For example, currently, the largest equity ETF by value tracks the JSE Top 40 index, which gives an investor access to the returns of a portfolio of the 40 largest listed companies on the JSE. It is important to note that these products are not limited to market-capitalisation-based indices. You can get access to “active” or “smart” indices. As these ETFs track the performance of underlying assets or indices, they follow a passive investment strategy, usually at a very low cost to investors.
Exchange-traded Notes
Exchange-traded Notes (ETNs) are fundamentally similar to ETFs but differ in one key dimension: they are notes (or debt obligations) issued by a regulated party, usually a bank. This means that there is credit risk – if the bank goes under, the investors must get in line with other creditors. It also means that they are fixed term – they expire after a period.
ETNs provide the holder with the returns to the underlying index which is specified in the ETN itself. This structure gives it great flexibility – the underlying index can be created from a combination of literally anything that is listed (and thus can be objectively valued).
As of the end of September 2023, there were 74 ETNs listed on the JSE, with the majority providing access to specialised global equity indices. Like ETFs, the underlying index is predefined and fixed and thus is a fundamentally passive investment in nature.
Actively Managed ETFs
An Actively Managed ETF (AMETF) is a new ETP that offers exposure to a Collective Investment Scheme (CIS) portfolio, in other words, one which is actively managed like a traditional investment strategy. These provide access to effectively the same investment solutions that are currently available via LISPs – but are now available through the JSE. The underlying investment product must be consistent with existing regulatory requirements of the Collective Investment Schemes Control Act (CISCA).
The AMETF universe is currently relatively small in South Africa, but more and more investment companies are planning to list their current funds via AMETFs. Dimensional Fund Advisors have recently converted all their mutual funds into ETFs – a value worth USD44-billion. The primary reason for the change is the improved access to investors offered by a public exchange.
Actively Managed Certificates
Actively Managed Certificates (AMCs) have the same legal structure as ETNs (notes issued by a bank) but do not have a fixed underlying index. They provide the returns to an actively managed underlying portfolio. Conceptually they represent a similar alternative to the AMETF, but do not have the same regulatory restrictions and thus can offer access to a wider range of underlying portfolios.
What opportunities and challenges does this new world offer financial advisors?
Clearly, these innovations bring additional investment choices which need to be managed. They also bring more opportunity for personalisation of advice and the design of investment solutions. Roland Rousseau of NeoBeta in a recently published report points out that these innovations can lead to a completely different advice environment where the key skills are, firstly, understanding your client’s personal characteristics; and, secondly, developing an appropriate solution for their individual needs across this wider and more accessible investment universe.
All this opportunity comes with the cost of more complexity. Advisors will, firstly, need to have the skills (or access to the skills) and technology to manage this new world. For starters, understanding your client objectively and more accurately will require the use of more valid and reliable measures of relevant psychological characteristics. The Money Fingerprint developed by Paul Nixon, head of behavioural finance at Momentum Investments, in conjunction with the University of Pretoria, is an excellent example of this type of innovation. Secondly, the development of individualised investment solutions will require a significant amount of bespoke modelling and reporting capabilities.
Globally, there are examples of such platforms which allow for such customisation of investment solutions. Rousseau cites the example of the Aladdin platform developed by BlackRock. Locally these do not currently exist but are likely to be offered soon as the benefits of these ETP innovations are recognised.
In short, the innovations we see in the ETP world are signifiers of a new, more flexible world of (potentially) cost-efficient, hyper-personalised investment solutions. However, access to these opportunities on its own is not sufficient – you need to know your client well enough to understand their unique attitudes and needs, and then have the right technology to design and manage an increasingly wide range of solutions that are becoming possible now. Investment advice is going to be a lot more than choosing the right fund for your client.
