An index tracking portfolio is defined as a discretionary managed personal portfolio product which simply tracks the markets in a diversified manner by investing in a range of low cost regulated Exchange Traded Funds (ETFs) which track local and global cash, bonds, property and equity market segments.
We employ a two-step process to select the most efficient ETFs in creating an ETF Portfolio. Once this strict selection process is complete, we allocate the capital by weight to each ETFs contained in the portfolio to produce the final desired portfolio.
Step 1: ETF Selection
There are a large and growing number of ETFs in the local and global investment universe making selection of the correct blend of ETFs complex and confusing for the average investor who wants to diversify their investment over many market segments at once.
Our process only considers vanilla ETFs. The reason is simple and its like baking a cake. We don’t use an instant cake mix which contains all sorts of different and complex ingredients and additives. We prefer simple and natural ingredients such as eggs, milk and flour and we want the best quality.
We therefore don’t use ETFs that contain a variety of complex and expensive mechanisms which attempt to beat the market – these are what we call “already baked products”. We prefer broad stroke vanilla ETFs as building blocks which are free from expensive and pre baked complexities. Vanilla ETFs provide uncomplicated, well-diversified exposure to the markets. Vanilla ETFs are able to tolerate the failure of a stock or two without harming the overall performance of the ETF and because they are vanilla, they are predictable, making it easier for us to extract their value in a well-controlled manner.
Step 2: Asset Allocation
There are only a few unique market segments such as local and global cash, bonds, property and equity, let’s call them “baskets”. We only use baskets which are well diversified from one another. This means that each basket (or market segment) must behave differently from the others. This is important as it is pointless thinking one is well diversified , but in fact are investing in segments or baskets that behave the same. This is called concentration risk, better known as “putting all your eggs in one basket” and we want to avoid this at all costs because it increases the inherent risk of a portfolio.
After we are satisfied with each basket, we proceed to place the most efficient ETFs (chosen in Step 1) into their respective baskets. For example, all the bond ETFs into the bonds basket, all the property ETFs into the property basket and so on.
We now have six or seven well diversified baskets each containing their respective ETFs which represent each market segment. We now select only one ETF from each basket to represent each market segment. This ETF must be the most efficient ETF meaning it must be the lowest risk, highest return ETF from each basket.
We now have the correct raw ingredients to bake our portfolios. These are called model portfolios, each model representing a risk band.
We have created five product risk bands to cater for each investors anticipated investment term coupled with their appetite or tolerance for risk.
|Investment term||Risk tolerance||Risk Band|
|1 – 3 Years||Low||Conservative|
|3 – 6 Years||Low – Medium||Cautious|
|6 – 8 Years||Medium||Moderate|
|8 – 11 Years||Medium – High||Growth|
Investors may invest in a model portfolio according to their needs.
TYPES OF INDEX TRACKING MODEL PORTFOLIOS
Tracks the cumulative performance of mostly money market and bond indices with a small proportion of global equity to attempt to boost returns slightly above the rate a bank would provide in a current account.
Tracks the cumulative performance of mostly bonds, low proportions of local money market, property and global equity.
Tracks the cumulative performance of most, or all of the asset classes.
Tracks the cumulative performance of mostly local and global equities with little or nominal money market, property and bonds
Tracks the cumulative performance of global equities, property and bonds.
BENEFITS OF INDEX TRACKING PORTFOLIOS
Easy to acquire
Investors can gain instant exposure to a wide variety of securities or assets without having to buy each of the underlying constituents individually, conducting extensive research, nor actively managing the underlying securities.
By purchasing an index tracking portfolio, investors receive immediate exposure to the performance of a wide variety of the top performing securities within an index thereby avoiding the risk of putting all your eggs in one basket by having to buy each of the underlying constituents individually which requires complex and time consuming activities like research and actively managing the underlying securities themselves.
Peace of mind
Indices are well regulated by both the Johannesburg Stock Exchange (JSE) and Financial Services Board (FSB) ensuring that investors are protected against unjust treatment.
Automatically re-invest dividends
Dividends are automatically re-invested by purchasing additional securities thereby boosting the overall performance of the portfolio.
Unlike owning a single shares and having to search for a willing buyer if you wish to sell your share, index tracking portfolios can immediately be bought and sold on any day the stock exchange is open.
Unlike purchasing a single share, exposure to indices via ETFs are exempt from Securities Transfer Tax (STT).
IMPORTANT THINGS YOU NEED TO KNOW ABOUT ETF PORTFOLIOS
Besides the price of the underlying securities, there is a once off trading fee for the transaction when the underlying securities contained in the portfolio are bought or sold. Annual investment management and administration fees will also apply.
Share ownership rights
Owning an index tracking portfolio does not give investors the right to vote at Annual General Meetings (AGMs) of the underlying securities, as you own a portion (unit) in the fund and not the underlying securities themselves.
Capital gains (profits) from the sale of portfolio are subject to Capital Gains Tax.
The purchase price of each underlying security within the portfolio will always vary slightly from the selling price (aka the net asset value or NAV of the underlying fund). This difference is attributable to the securities management costs and market forces such as supply and demand.
The price of underlying securities in the portfolio fluctuate, but because of the advantage of diversification, the risk of losing money is lowered.