BY ANTONY MUTUNGA
Even though they are not always beneficial as they depend on one’s ability to understand the market, Investment funds are one of the best forms of earning wealth. Some people have gained wealth from these funds while some have thrown away their hard earned cash in pursuit of the same. The industry requires one to have knowledge on the behavior of the market, to know when to buy and when to sell.
There are different types of investments funds; mutual funds – an investment vehicle made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets; hedge funds – an investment fund that pools capital from a limited number of accredited individuals or institutional investors into in a variety of assets, often with complex portfolio-construction and risk-management techniques; index funds – a mutual fund or exchange-traded fund (ETF) with specific rules of construction that are adhered to regardless of market conditions
The former has however received more accolades. The pooling together of investors to form these funds led to their growth over the years making them such a dominant force. According to Statista, a statistical portal, in 2014 the assets held by mutual funds globally were valued at $31.38 trillion.
However, the demand is now shifting to another investment fund known as the Exchange Traded Fund (ETF), which is rising in the ranks and threatening to challenge mutual funds to the throne. ETF is an investment fund that tends to combine the range of diversified portfolios with the simplicity of trading stocks. The fund resembles an index fund but it also acts like a common share of stock as it can be traded on the stock exchange.
Starting off in the late 1980s the ETFs have come a long way to becoming one of the most popular financial innovations to hit the market since the introduction of the mutual funds in 1770s. Taking the industry by storm, ETFs are being considered the future of the investment industry because they have become quite popular among millennial investors who feel these are the best investment vehicles.
ETFs are created when an institutional investor, a bank for example, or a market maker referred to as an authorized participant (AP) pools together a large number of securities that are of a same index into a portfolio. The portfolio is then exchanged with the ETF sponsor/manager for a large number of ETF shares known as creation units, which are then minimized to smaller shares and sold in the open market to the small investors.
The fund usually tracks the performance of stock indices, which are normally comprised of many types of stocks. When an investor acquires an ETF share they are normally investing in the performance of bundle of securities mostly involved in particular sector. The ETF shares tend to focus more on a sector in whole rather than a particular stock so that one is able to profit even if a particular stock fails and the sector flourishes. For example, if one was looking to invest in the mining sector then one would be concerned if dealing with a particular stock as it may encounter a problem hence causing one a loss. However the sector in whole may have a growth and outperform the market hence proving it is better to buy into the sector so as to reduce the risk. But alas! This also depends on which sector one is investing in. This is because in some sectors the stock strongly mirrors the overall sector.
ETFs were valued at $2.9trillion as of 2015 with the rise being attributed to its advantages over other funds. Investors were mostly attracted to this investment vehicle due to its higher liquidity. As compared to mutual funds that can only be bought and sold at the end of the day once trading closes, the ETF can be traded anytime when the market is open making it easy for those who want to liquidate.
Apart from better chances of liquidity, ETFs are also easy and cheap, as they have no minimum requirements. One can even buy one share. They tend to have lower costs. This is caused by their structure, which requires a passive management. They also have a minimum expense ratio unlike mutual funds, which have higher costs mainly because of an active management.
However, this investment does not always enjoy lower costs because its shares are acquired through a broker. The more an investor purchases ETFs the more the brokerage commission increases, pushing ones cost. These increased trading costs cause the fund to lose its appeal to investors.
ETFs are considered to be more tax efficient as compared to mutual funds that trigger capital gain taxes whenever its investors are redeemed through sale of portfolio assets. ETFs usually reduce the tax burden on the investors if they are redeemed through shares and not cash, which most investors actually prefer.
ETFs have made it possible for all kinds of investors to be able to gain access to investments such as precious metals like gold and silver. “Instead of just buying one stock you get exposure to a number of different listed securities or even an asset like gold or platinum,” says David Ouma, product development manager at the Nairobi Securities Exchange
The Capital Market Authority (CMA) issued guidelines on the operation of ETFs in late 2015, before they could introduce the ETF market, as they targeted investors by offering them another investment option to invest in.
CMA Chief Executive Officer, Paul Muthaura says Investors should view ETFs as long-term investments “designed to not only diversify investment horizons but also reduce exposure to significant price fluctuations that sometimes characterize arbitrary buying and selling of securities and thus minimize their risk exposure.”
To date the product is yet to be availed in the Kenya market although there are overseas ETFs that maintain exposure to Kenyan listed stocks including Guggenheim Frontier Markets ETF (FRN), iShares MSCI Frontier 100 ETF (FM), EG Shares Beyond BRICs ETF (BBRC) and VanEck Vectors Africa Index ETF (AFK) all hold Safaricom Limited stock (SCOM).
As we await for the NSE to introduce this exciting product to the market, investors especially millennials need to start being familiar and understanding this investment product to ensure when it finally hits the market, they get to take advantage, earn big from it and do away with poverty.
