An extraordinary number of beginner investors find themselves asking what Exchange Traded Funds (ETFs) are and how they really work. This comes after the explosion in popularity in recent years, as retail investors start realising how such funds are actually performing better compared to mutual funds and individual stocks.
ETFs can be thought of as a mutual fund that seeks to only do one thing, and that is, to mimic the index that it is tracking. It aims thereby to receive the benchmark market returns.
STI ETFs And How It Tracks The STI
The Straits Times Index (STI) is made up of 30 of Singapore’s best and biggest companies. These companies are representative of the broad Singapore market, accounting for about 77.29% of the total value of SGX listed companies (as at 30 Jun 2015).
Due to the sheer volume of the Singapore market that these 30 stocks represent. The average returns given by these companies are usually referred to as the market returns.
STI ETFs track the component stocks, in its exact weights, on the STI. What this means is that the STI ETF tracks the STI by constructing a portfolio of all the stocks on the STI in the exact weight each component stock carries.
So, for example, if DBS Group makes up 12.5% and SingTel makes up 10.8% of the STI, the STI ETF will allocate 12.5% and 10.8% of its funds to holding DBS Group and SingTel stocks respectively. The same concept applies for the remaining 28 stocks on the STI.
The STI is reviewed every quarter, and any changes made to the STI would be replicated by the STI ETFs. In Singapore, there are two ETFs that track the STI, the SPDR STI ETF and the Nikko am Singapore STI ETF.
Why Buy STI ETFs?
Because STI ETFs track the STI, retail investors would be able to achieve diversification simply by buying the STI ETFs. Each lot of STI ETF stock bought would automatically make you an owner of 30 of the best companies operating in diverse industries in the country. The weightage in each company that you own would be in exact proportion to how they are allocated on the STI.
The great thing about the STI ETFs investing is the fact that they will be around a whole lot longer that each individual stock. What this means is that as years go by and stocks are reviewed, added or removed from the index, the STI ETFs will automatically buy and sell these companies accordingly. For example, companies such as Jardine Matheson Holdings, Jardine Strategic Holdings and Olam International were replaced by UOL Group, Yangzijiang Shipbuilding Holdings and Sats as recently as 21 September.
The STI ETFs also offer low management costs, in the range of 0.3%, compared to mutual funds and unit trusts, which charges about 1.5% and above for their service.
In addition, the two STI ETFs we mentioned above are traded on the SGX, which means retail investors like you and I can easily buy or sell our shares in it. We also receive dividends from it. This makes the investment transparent and user-friendly. It’s good to note that the difference between the returns of the STI and the STI ETF are also minuscule.
Making Sense of ETFs
The bottomline about ETFs are that it offers many of the advantages of a mutual fund, and much more. Investors are able to invest passively, without having to learn, study or worry about the intricacies of each and every stock that they are investing in. For the average person who wants to start investing in stocks but who do not enough time or knowledge to be able to make a good decision, ETF investing provides a realistic alternative worth considering.