Day: 11 May 2020

In these times of heightened market volatility, exchange-traded funds (ETFs) have delivered on the main attributes that attract investors to utilising the wrapper—liquidity, transparency and cost efficiency—according to our Head of EMEA ETF Capital Markets Jason Xavier. He explores the subject a bit further and dispels some of the recent comments directed towards fixed income ETFs in particular, which he says is inaccurate.

A tin of soup is a tin of soup! For years, ETF practitioners like myself, my colleagues and industry counterparts have often said, “ETFs do what they say on the tin!” The attributes of ETFs include liquidity, transparency and cost efficiency. Over the years, our team has suggested investors consider complementing their portfolio construction with either a core or tactical allocation to utilising the ETF wrapper.

In our view, the events of the last two months and the continued dislocations and volatility in the underlying market caused by the COVID-19 pandemic, point to an ever-more pressing case to utilise ETFs for all of the above-mentioned benefits. In particular, the liquidity and transparency in heightened volatile periods. At the height of the recent coronavirus-driven volatility, some critics suggested that ETFs—in particular fixed income ETFs—were causing dislocations in the bond market, and many fixed income ETFs were wrongfully trading at a discount to the net asset value (NAV) of those respective funds.

To fully appreciate why this is an inaccurate assessment, it’s worth taking a step back and appreciating the different market microstructures between fixed income (bonds) and equity securities (stocks). Trading in the bond market is still driven primarily by the over-the-counter (OTC) market—where parties trade directly, off exchange. In extremely volatile periods, fixed income ETFs (which do trade on exchange) may sometimes trade away from the NAV of their underlying index. This is because the NAVs are often calculated based on delayed prices, not on real-time executable prices which ETF market makers can take action on.

However, what we have seen in reality during this recent period of turmoil is that fixed income ETFs have actually given clients actionable price discovery and on-exchange transparent pricing within the traditionally OTC-driven asset class, and it’s clear that many now appreciate how ETFs are intended to work. While some commentators have tried to suggest the recent market turmoil has exposed an issue with the wrapper, we’d like to highlight how it actually cements the fact that “ETFs do what they say on the tin”.

Let’s take the scenario just mentioned of a fixed income ETF trading intraday at a discount to the ETFs NAV. Firstly, the accurate intra-day pricing illustrates the intraday liquidity the ETF wrapper offers. While we have seen markets down percentages intraday, the ability to take a trading action of a fund holding in real-time illustrates the ETF’s ability for a valuable tool in liquidity management.

The second component is transparency. While ETFs are transparent via daily holdings disclosures, this scenario also points to transparency around execution. As highlighted earlier, the ability for ETFs to be mark-to-market intraday and for ETF market makers to accurately price the underlying basket and offer accurate bid/offer (buy and sell) prices in real-time gives investors full transparency around their cost for execution, and in volatile times, the extra cost for the same execution.

The third attribute is cost efficiency. Again, while the efficiency of the ETF wrapper helps keep total expense ratios to a minimum, this scenario also points to cost efficiency for all types of investors—whether they want to direct assets toward a new ETF investment, sell out of an existing one, or maintain their current portfolio. As we’ve outlined, the ETF’s ability to accurately price the underlying basket ensures incoming/outgoing investors accurately pay for entering/exiting a fund independently. As a result, ETFs keep costs independent and fully transparent, helping to ensure existing shareholders are not penalised by new investor flows. Additionally, the executable transparency for incoming/outgoing investors is always preserved, even while underlying markets are experiencing times of stress.

 

 

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All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Brokerage commissions and ETF expenses will reduce returns. ETF shares may be bought or sold throughout the day at their market price on the exchange on which they are listed. ETFs trade like stocks, fluctuate in market value and may trade above or below the ETF’s net asset value. However, there can be no guarantee that an active trading market for ETF shares will be developed or maintained or that their listing will continue or remain unchanged. While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.

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This information has been accurately reproduced, as received from Franklin Templeton Investment Management Limited (FTIML). No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

By John Rekenthaler, Vice President of Research for Morningstar.

 

What’s more, the two are drifting even further apart.

Bad News, Good News
In 1982, the unemployment rate started high and finished higher. It entered the year at 8.6% and concluded at 10.8%, its steepest level since the Great Depression. That was the first time that I had paid attention to employment statistics, because I was approaching my college graduation, and I must confess I was worried. (Correctly, as it turned out: I would not land a permanent job until summer 1984.)

To my surprise, stocks surged in 1982. The S&P 500 gained 21.6% on the year, well above its average. That made no sense to me. Not only was unemployment rising, but seasonally adjusted gross domestic product fell during every quarter of 1982. The media called it “the Reagan recession.” (It wasn’t until later that I realized presidents cause neither busts nor booms.)

What I did not know, because I was not then an investor, is that stock prices are only tenuously connected to general economic conditions. For one, stocks anticipate future developments rather than dwell on current affairs. For another, neither employment statistics nor GDP growth directly affect equity prices. The primary drivers are instead two sets of expectations: 1) future earnings and 2) future interest rates, with the latter being used to discount the former.

Disconnected
Later I learned that it is difficult to find even an indirect relationship between a country’s GDP growth rate and its future stock-market returns. In perhaps the most widely cited of such studies, London Business School professors Elroy Dimson, Paul Marsh, and Mike Staunton found a negative correlation between national per capita GDP growth and stock performances. (When aggregate GDP growth was substituted, the correlation became slightly positive)

In theory, expansion floats corporate boats. In practice, many factors affect whether an economy’s general success reaches companies’ bottom lines. Managements may squander their good fortunes by making poor investment decisions. Workers may collect the gains instead, through wage inflation. Or governments may enjoy the benefits, through corruption or excessive taxes. The economy is not the stock market.

This year has powerfully reinforced that lesson. Unofficially, unemployment is currently far above 1982’s apex, although the official numbers are lower, as they do not count workers who have been sidelined but who expect to return to their positions. At negative 4.8%, the first quarter’s GDP slide was deeper than any suffered in 1982, and of course that was only the beginning. The second quarter’s GDP decline is forecast to approach 30%

Yet stocks have rallied strongly, even as the economic news has deteriorated. (When stock prices began to rise in late March, the consensus second-quarter GDP outlook was for an 18% decrease. Since then, stock prices have steadily climbed, while the GDP predictions have steadily fallen.)

The Few and the Many
To be sure, the headlines do not relate the full story. The S&P 500 has recovered so powerfully as to make its year-to-date loss of 12% unmemorable, aside from the abruptness of the path. Meanwhile, small-company indexes have fallen twice that far, and small-value indexes, which represent the largest number of publicly traded companies, are down 30%. Those are genuinely poor results.Nonetheless, as large companies account for about 80% of U.S. stock-market capitalization, their performance reflects most investors’ experiences. And those experiences have been benign compared with the awful showing of the overall economy. Two additional factors have weakened the already tenuous link. One is the increasing divergence between the “have” companies and the “have nots.” The other has been the federal government’s aggressive intervention.

While most businesses are at best struggling, a happy few are booming. This fact is not only reflected in the performance gap between the large- and small-company indexes, but also by the disparity in fortunes between public and private companies. Because publicly traded firms operate nationally (if not internationally), they tend to be technologically capable and therefore positioned to compete during social distancing. Local businesses, in contrast, are likelier to be brick-and-mortar affairs that are hampered by movement restrictions.

In other words, that millions of workers have been released by local businesses–or national firms in industries that have been devastated, such as airlines and hotels–is relatively immaterial to the stock market’s leaders. As long the layoffs don’t lead to a ripple effect, wherein the broader economic woes affect their revenues, their stocks quite logically can rise even as other businesses fall.

Once Again, The Fed Put
This much I knew six weeks ago. What I did not realize was that, at least to date, the ripple effect would not occur. One reason has been banks’ relative health, which has forestalled the financial panic that bedeviled 2008’s stock market. Happy banks do not always make for happy stock prices, but unhappy ones inevitably lead to misery. However, the other explanation lies not with the marketplace but instead with its overseers: The federal government has been a most generous host.

Both the Federal Reserve and Congress, through the CARES bill, have rained money onto the economy. Such actions have helped preserve consumer spending power. In addition, they have encouraged equity investors by demonstrating that both major parties–there has been little disagreement on either side of the aisle–will spend what they believe is needed to maintain some semblance of normality.

Government intervention is the new and updated version of “The Fed Put”: the idea that the Federal Reserve could always support equity prices, whenever it desired, by cutting short-term interest rates. Those rates are currently at zero, so that game can no longer be played. But the Federal Reserve can continue its newer technique of buying bonds in the open marketplace and flooding the banks with liquidity, and Congress can pass new stimulus bills. It likely will.

Whether such activity will benefit investors more than workers remains to be seen. Thus far, it has.

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MeDirect Disclaimers:

This information has been accurately reproduced, as received from Morningstar, Inc. No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

An article written by Ray Calleja: Head – Private Clients, MeDirect

Investing in a mutual fund may seem daunting and overwhelming at first. Instead of choosing just one company and one stock (one price, one ticker, one stock exchange, etc.), you suddenly need to look at long lists of different mutual funds. Before you get mired in those details, you need to decide whether you want some help choosing your funds or whether you would rather do it on your own. Like most choices in life, both paths have benefits and drawbacks.

Maybe you don’t have the time or interest to design your own mutual fund portfolio. If that is the case then speaking to one of our Financial Advisors at MeDirect is your next step. We can help you pull together a financial plan and a basket of funds that can help you achieve your goals.

The advantages of working with an advisor are clear: You have someone helping you make financial decisions, understand the fund and market performance, and making sure you are sticking to your important investment plans and goals.

There are costs involved, of course. But we feel that the Advisory service provided by MeDirect is very reasonably priced. As we discussed in previous articles, the Fund Manager of each Mutual Fund charges an annual management fee but a portion of this fee is paid back to the Bank by the Fund Management Company and on average this is 0.5% per annum on the value of the investment in the fund. The trading fee to buy into a fund is currently 0.75% of consideration, which again is a very competitive rate. There are no additional costs with MeDirect’s investment advisory service – no additional management or custody fees.

Those with the time and interest to learn about investing and to monitoring their own portfolios, can invest in funds without the help of an advisor. If you choose to invest on your own, then you can use the MeDirect online trading platform to invest in mutual funds from a very large selection of almost 550 funds. The online fee to buy into mutual funds at MeDirect is just 0.5% of consideration and you can invest as little as a few hundred euros, which is particularly useful and attractive if you want to invest a regular monthly or quarterly amount to build up your nest egg.

New investors who plan to buy more than one fund might choose one of the larger fund houses, mainly because these fund houses are diversified, since they offer equity and bond funds, US and international funds, and large- and small-company funds. Most fund investors eventually own more than one fund because of the need for diversification.

This brings us back to the decision of whether to use a financial advisor or to go it alone. More choice often leads to lesser ability to make good decisions and investors can make the classic mistake of spending too much precious time on their finances when they could be spending it on higher priorities, such as family, health or personal goals.

There is also a significant aspect that investors need to take into account in the do-it-yourself path: Money is one of the most emotion-provoking things on earth. You must be able to avoid your worst enemy – yourself by not succumbing to the normal and damaging emotions of greed, fear, complacency and over-confidence. An investment advisor or financial planner can think about your money with little or no emotion but you may not be able to separate the two.

A good financial advisor will look at your money logically and help lay out an objective road map to follow so you can reach your future financial goals while living your present life more fully.

Having decided whether to invest with the help of an advisor or not, the next step would normally be how much and when. If you have money to invest, you will need to choose one of the following approaches:
1. Wait until you believe it is the right time to invest your sum or
2. Invest the entire amount immediately or
3. Put a little bit to work at a time

You should be aware that the route you choose can have a profound impact on your total return.

Trying to Time your Investment

Holding off on an investment until you sense the time is right is one option. That can mean when the fund’s performance falls, when it rises etc. Such a strategy is often called market-timing.

As you can probably sense, we as a bank are not keen on market-timing. Evidence suggests that it just doesn’t work. Predicting the future has never been easy, and this can happen with anything in life not just investing. Studies from our investing partners Morningstar have shown that investors’ timing often leaves something to be desired – they buy in when a fund is ready to cool off and sell when its performance is ready to pick up. And that can be so true especially at this time of so much high volatility during this corona virus pandemic.

In an experiment conducted by Morningstar that went back 20 years and assumed that in each quarter, an investor chose to own all stocks (represented by the S&P 500) or all cash (in their experiment, Treasury bills – equivalent in our case to Government stocks). A market-timer who picked the better performer half the time still ended up way behind the market after two decades. Morningstar found that not until the timer’s hit rate reached 65% did he beat the S&P 500. In other words, the market-timer had to be right two out of three times to justify the effort.

This is largely because over time, the stock market has notched higher gains than holding cash. Botching a market-timing decision usually means sacrificing good performance. Worse still, missing a period of strong returns means giving up the chance to make even more on those gains, thanks to the effects of compounding. That is, each year you earn returns on the returns you earned in prior years, as well as on your initial investment.

Lump-Sum Investing

If market-timing is a losing strategy, what about the opposite: putting all the money to work at once? Many financial advisors recommend this approach above the others, because the market goes up more often than it goes down.

Here’s an example. Say Investor A decides to invest an amount of €12,000 all at once in one fund while Investor B, who also happens to have €12,000 to invest, instead places roughly €2,000 per month in the same fund over the next six months. The fund consistently rises in value during that time. The chart below illustrates what would happen to the two investments.

Investor A ends up ahead, because he owns more shares at the end of the six-month period. And he owns more because, due to the consistently rising value of the fund, Investor B could not afford to purchase as many shares as Investor A had purchased originally. But what happens if the value of the fund fluctuates dramatically during those six months?

In this case, Investor B ends up in the lead. By investing a fixed dollar amount in the fund every month, Investor B bought more shares when the price was low, fewer shares when the price was high, and ended up with more shares after six months. So, he ended up with 6,224 shares against the 6,000 shares of Investor A.

Such drastic fluctuations in NAV are rare. Because the stock market generally goes up more often than it goes down, most investors will receive the best long-term results by lump-sum investing.

Cost Averaging

However, there are many investors who feel emotionally much calmer by investing at regular intervals. In the US, this is called Dollar-Cost Averaging (or DCA). Not only might this investment strategy be an effective way to grow your portfolio over time; it can also be a prudent way to navigate the complex and often nerve-racking conditions of a stormy economy, such as the one we are living now during this pandemic. DCA investing as a matter of principle and habit can help you eliminate a lot of emotional trouble – thinking about whether to invest, how much to invest, whether to stay out, and when to get back in.

Investing in small sporadic amounts may not be the path to greater return, but we still think that cost averaging, or investing a set amount on a regular basis, is a great method of investing. As we explained, cost averaging can reduce risk. If your mutual fund declines in value, the worth of your investment is less, even though you still own the same number of shares. In the same way that cost averaging will net you more shares in a declining market, it can curtail your losses as the fund goes down. The chart below illustrates this point.

In this example, both Investor A and Investor B lost money (remember, they each started with €12,000), but Investor B lost less by cost averaging. Investor B kept the cash sitting on the sidelines and when the fund rebounds, Investor B also will be in better shape because he owns more shares of the fund than Investor A.

The second reason we are in favour of cost averaging is that it instills discipline. Investors often chase past returns, buying funds after a hot performance streak. And they will sell funds when returns slow down or decline. That is a bad idea and it is just like trying to time the market. Cost averaging prevents you from doing that because you are buying all the time.

Our conclusion is that while market-timing is not ideal (but some still try it), whether you invest all at once or a little at a time, depends on how much time you have to invest and whether your primary goal is maximizing return or minimizing risk.

The shorter your time horizon, the greater chance you take of losing money with a lump-sum investment. However, if you had €50,000 to invest, it probably would not make much sense to invest €2,000 per year for the next 25 years! Over long-time frames, funds go up more often than they go down, and when they go down, they eventually bounce back. It is almost certain that the NAV you would pay 10 years from now would be higher than the NAV you would pay today.

Therefore, one may consider combining the two strategies: Invest as much as you can today and vow to invest a little more each month or every quarter.

 

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The above is for informative purposes only and should not be construed as an offer to sell or solicitation of an offer to subscribe for or purchase any investment. The information provided is subject to change without notice and does not constitute investment advice. MeDirect Bank (Malta) plc has based this document on information obtained from sources it believes to be reliable but which have not been independently verified and therefore does not provide any guarantees, representations or warranties.

MeDirect Bank (Malta) plc, company registration number C34125, is licensed by the Malta Financial Services Authority under the Banking Act (Cap. 371) and the Investment Services Act (Cap. 370).

The financial instruments discussed may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in any of the products discussed you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.