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What are Exchange Traded Funds (ETF)? Overview of ETF in the Philippines

The Philippine Stock Exchange (PSE) has recently announced that Exchange Traded Funds (ETF) will soon be launched to the market and ultimately listed and traded in the local bourse. Here at PinoyMoneyTalk, we welcome this new development since we believe ETFs provide investors with more avenues for investment, on top of current alternatives such as stocksbondsmutual funds and UITFs, among others.

Before we all jump at this opportunity, let’s first find time to understand what this new investment asset really is.

What are Exchange Traded Funds?

Exchange Traded Funds or ETFs are open-end investment company that tracks a basket of assets and traded on a stock exchange.

What does it mean by “open-end” investment company?

As an “open-end” investment company, an ETF can issue and redeem shares to the public anytime. In contrast, a “closed-end” investment company has a fixed amount of shares available to the public and, once fully subscribed, new investors can only purchase shares, not from the company anymore, but from other investors. The “open-end” characteristic of an ETF makes it more liquid and, as such, can be easily converted to cash with a known market price.

What does it mean by “tracking a basket of assets”?

The “basket of assets” refer to an index, a benchmark figure used to describe the overall performance of a market. In the Philippines, the commonly used index or basket of assets is the Philippine Stock Exchange index (PSEi), a basket of 30 PSE-traded companies that describes the general performance of all Philippine stocks and, ultimately, the Philippine economy. As of September 2012, the PSEi is composed of these 30 companies.

By “tracking” the index, an ETF utilizes a passive trading strategy in which its ultimate goal is merely to mirror the performance of the index. For example, the PSEi ended the year 2012 with a 32.95% growth. An ETF that tracks the PSEi would try its best to achieve that same performance, although, of course, it would not be surprising if a slight variance occurs. Rarely would an ETF beat the benchmark index since ETFs are not usually actively managed, that is, they are not designed to beat the performance of the index.

What’s the difference between a stock and an ETF?

When an investor buys a stock, he or she invests in that company and expects to profit from the growth of that company. Investors of ETFs also expect to profit from similar growth of underlying companies included in the index, but they are more diversified since there are more companies included in the index.

This diversification strategy is a two-edged sword. If one company is growing profitably, direct investors would also profit hugely from the investment. In the case of an ETF investment, however, even if one company grows exponentially, if another company in that index is underperforming, the income from the ETF will be tempered.

In cases of severe downturns, meanwhile, a direct investor of one losing company would suffer from stock price declines. An ETF tracking a diversified index, on the other hand, would minimize its losses because of the diversification strategy.

In terms of liquidity and tradeability, stocks and ETFs are very much alike. Both instruments can be easily bought and sold in the exchange during trading hours. They can both be traded between or among investors, without the participation anymore of the ETF issuer.

Although ETFs will have its Net Asset Value per Share (NAVPS) at the end of every day, the price at which an ETF may be bought or sold may differ and, like stocks, this price depends on the expectation of the investor in the future cashflow of the basket of assets comprising the ETF.

What’s the difference between ETFs and Mutual Funds/UITFs?

Mutual funds and unit investment trust funds (UITF) are still slightly different with one another (see Comparison of Mutual Fund vs. UITF), but they both refer to a collective scheme that pools investments from the public to invest in various asset classes.

ETFs are similar in the sense that they collect investments but, instead of actively trading to beat the index as in mutual funds or UITFs, the money is invested to track the performance of an index. (It should be noted, though, that some mutual funds and UITFs now are designed to track the PSE index.) It can then be expected that ETFs will have similar or slightly lower returns than the tracked index. Rarely, though, will an ETF have higher returns, unless the fund is actively traded.

In terms of pricing, ETFs, mutual funds and UITFs all have end-of-day NAV, representing the Net Asset Value of all underlying securities owned by the fund. Mutual funds and UITFs are required to disclose their NAVs at the end of the trading day.

In the case of ETFs, meanwhile, the PSE additionally requires them to disclose the iNAV every fifteen (15) seconds during any given trading day. The iNav is an approximation of the current value of the basket of securities on a per share basis. This supposedly tells investors the real-time value of their ETF investment in order for them to have an idea of the current market price of their ETF. This is the guiding price that ETF investors can use to consummate a buying or selling transaction on the exchange.

What are the listing requirements for ETF companies?

In the draft ETF rules issued by the PSE, an ETF applying to list must have a minimum paid-up capital of at least P250 million. The ETF company may offer its securities to the public upon approval of listing application, but will not be covered by the IPO listing rules of the PSE. The lock-up and track record requirements in the IPO listing rules will also not apply.

In terms of the index that the ETF endeavors to track, the PSE requires that underlying securities comprising the index must be listed and traded in a registered exchange and have sufficient liquidity. The ETF shall also disclose the liquidity criteria and methodology in the Fund Prospectus that will be available publicly.

What are the continuing listing requirements for ETF companies?

Like regular minimum public ownership rules, ETFs are required to maintain public ownership of at least 10% of its issued and outstanding shares.

The ETF must also have an Investor Relations Office whose role it to manage the fund’s investor relations program and provide facilities for investors to exercise their rights. Also, the general structured and unstructured reportorial requirements shall apply to ETFs under the Disclosure Rules of the PSE in addition to the reportorial requirements under the Securities and Exchange Commission ETF Rules.

When can we start trading and investing in ETFs?

The PSE has recently finished receiving public feedback on its draft ETF rules. We can then expect the PSE to finalize and approve the rules in the coming weeks. As per the PSE timeline, ETFs should be available to the public within the 1st quarter of 2013, that is either in February or March this year. Let’s see if this indeed pushes through in the coming 1-2 months.

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About this post: etf philippines, exchange traded funds philippines, etf vs uitf, psei etf philippines, etf company in philippines

9 thoughts on “What are Exchange Traded Funds (ETF)? Overview of ETF in the Philippines”

  1. Bobit Ebarle says:

    I don’t understand why there would be a slight variance between an ETF tracking the index and the actual performance of the index. What would cause such a variance?

    1. Allan Miranda says:

      There’s a variance because an index itself has no fees and noone actually invest on
      the index.. While an ETF tracking an index has an expense ratio (most
      probably should be <1%) due to being a 'passively' manage fund by a certain
      finance institution.

    2. kabaliktaran says:

      operating costs of the fund + errors, assuming the index is not fully replicated

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