Betashares Offers Commodity ETFs for Australians

Link: BetaShares

Most people invest in shares, bonds, and real estate. Shares and real estate tend to perform well during an economic boom. Government bonds are seen as safe investments since they are backed by government, and many people hold government bonds or government bond funds in addition to growth assets such as shares and real estate in order to diversify. But what about commodities?

The word "commodity" is not perfectly clear, but investing in commodities involves investing in such things as gold, oil, soybeans, wheat, and livestock. It is an investment in hard assets that are more often than not necessary for humankind. Investment in commodities are perfect not really for periods of economic booms or economic recessions. Rather, commodities are excellent to hold during times of stagflation, that is, a combination of stagnant economic growth and inflation.

One way of combating massive inflation is to adopt The Alpha Strategy, that is, hoarding essentials such as rice and toilet paper in your home. The less extreme option is to buy a commodity ETF.

For Australians, a firm called Betashares provides a diverse range of ETFs, including an ETF that invests in crude oil futures. I am thinking of using my margin loan to purchase a good chunk of commodity ETFs via Betashares but I am unsure if I should. Perhaps shares in resource companies already provide sufficient commodity exposure. The fact the Australian dollar is a commodity currency also provides some exposure. Then there is the worry about the safety of synthetic ETFs (read Quant Congress USA: Avoid synthetic ETFs, says Avellaneda - Risk.net) with some saying they are fine for short-term trading but not appropriate for long-term investing due to counterparty risk.

If anyone has any deep knowledge on this issue, please comment.

Strong Aussie - Time to Buy Foreign ETFs?

The Australian dollar has now reached parity with the US dollar, meaning that one Australian dollar equals one US dollar. This is the first time this has happened since the Australia dollar was floated way back in 1983.

Many Australians are taking advantage of the strong Australian dollar by going on holidays overseas. Perhaps one good idea is to take advantage of the strong Australian dollar by buying other countries' shares. Exposure to foreign shares can easily be achieved via iShares' range of foreign ETFs.

Looking purely at the dividend history of these foreign ETFs, the best is the iShares MSCI Singapore ETF, which has distribution rate of 5.22% so far. The Australian dollar has indeed been strengthening against the Singaporean dollar for the past year. The Singaporean economy has been the fasting growing in the world post-GFC. The country seems to be ruled by very competent people and the population seems to be highly educated, although my discussions with people suggest that the Singaporean education system does not foster critical thinking. This lack of criticial thinking is evident in the fact that even though most Singaporeans have a lot of faith in their country's economy they are mostly unaware that Singapore has one of the world's highest public debt. The size of the public debt is greater than the size of Singaporean GDP. In Singapore's defence, I was told that much of this debt is held by Singapore's pension funds. That is, most of the government debt is held by Singaporeans. In America and Greece, much of the government debt is held by foreigners. I am not entirely sure how this makes a difference. The problem with government debt is that it needs to be paid off in the future, which means higher taxes, which slows economic growth. However, Singapore has a very large sovereign wealth fund (Temasek Holdings), so rather than resorting to high taxation to fund their debt, they can use their investments. Singapore's level of taxation is currently phenomenally low, especially compared to countries like Australia and the US.

Even if Singapore's government debt may not be a problem, there are other risks with investing in Singapore. An investment in iShares MSCI Singapore ETF exposes you heavily to the finance sector. A browse of the holdings of this ETF reveals that many of Singapore's largest listed companies are holding companies, banks, and real estate trusts. Buy buying into Singapore you are not really getting that much diversity in terms of sectors. Singapore's focus on finance takes it heavily dependent on other economies and can even, in my opinion, make Singapore's economy rather correlated to Australia's economy. After the GFC, Australia's economy rebounded strongly and currently interest rates in Australia are very high, much like interest rates in Singapore. Australia and Singapore seem very similar in that both are trade-focused and heavily dominated by the finance sector. Both the countries have increasing real estate prices. The main difference is that Australia has a massive resources sector while Singapore does not.

Unlike Singapore and Australia, Europe and the US has been dropping its interest rates, and the US has resorted to printing money to stimulate its economy. This has led to a devaluation of the US dollar to other currencies. This is a great opportunity then for Australians to buy American shares. Currently corporate America is paying virtually nothing in terms of divdends, so a better alternative is to buy the iShares S&P Global 100, which invests in 100 large, multinational companies. The benefits of investing in this, in my opinion, is that you are investing in very high-quality, internationally recognized companies. Most of these companies are European and American, meaning you buy for cheap in the countries that are hardest hit by the GFC. This then allows you to truly diversify your portfolio if, like mine, it is overweight in the shares of high-risk, high-interest rate countries like Australia. The yield on the Global 100 ETF is around 3 or 4 per cent, which is not bad but not as good as Singapore or Australia. If the Australian dollar does take a hit, investment in this ETF should pay off.

The argument for investing in the US now is that all the money printing will eventually jump start the economy again and once that happens, the American dollar will regain its strength. This is the argument put forth by Peter Switzer, the permabull, who in an piece in Yahoo!7 Finance titled Ignore Bears, But Not History, says the following: "I'm an optimist and trade long only and so I search for confirmation that my investment strategy is right." Is this guy crazy or what? You don't choose to be an optimist and then collect evidence to prove you are right. You look at the evidence first and then based on the evidence make a decision about whether you want to be optimistic or pessimistic. That is how a proper investor should behave.

Claymore Frontier Markets ETF

Claymore have released the Claymore/BYN Mellon Frontier Markets ETF (FRN), an ETF that invests in frontier markets, which are small volatile countries like Poland, Chile, and Lebanon. They are not emerging market such as China and Russia who are relatively more developed.

I must admit that my interest for investing in frontier markets comes mainly from the appeal of investing in something exotic and different. Because I try to be as thrifty as possible, investments are the only area where I can release my consumerist desires. I therefore love to shop for investments.

Unfortunately for me, this frontier markets ETF is not available for Australians. Only the Americans can get it. It is purchased I think on the New York Stock Exchange.

Should I Use Leverage?

At the moment I put about $1000 per month into a diversified global stock mutual fund. In 2009 I hope to be able to increase my savings from $1000 per month to $4600 per month. However, what if I can't get a higher paying job by next year? What if I am not good enough?

There may be a way I can still be a millionaire by 35 and that is through gearing, or borrowing money to invest.

I've heard horror stories about margin loans, so I am a little hesitant. However, I am drawn to the idea because of the potential gains.

By the end of this year I should have a net worth of $40,000 and if I assume that I am not able to increase my savings and still save $1000 per month, I can still become a millionaire by 35 assuming stocks grow at 8 per cent a year and I leverage with gearing level (or LVR) of 60 per cent. I calculated this using BT Financial Group's Margin Lending Calculator.

One way I can avoid the messiness of margin loans and escape the threat of margin calls is to invest in an internally geared mutual fund. The website 2020 Direct Invest has a list of geared mutual funds. Most seem to be offered by Colonial First State, which is a subsidiary of the Commonwealth Bank.

Suppose I am not able to invest $2,300 per fortnight next year, which is my plan. What I can do then to be a millionaire by 35 is to salary sacrifice into super to minimize taxes and get co-contribution from the government and also to put a certain amount into CFS geared funds (investing in both Australian and non-Australian companies). The degree to which I will gear depends entirely on how much I need to gear to become a millionaire by 35. I understand that if I invest $2,300 per fortnight and gear completely, I can have not $1 million by 35 but about $1.6 million. However, gearing this much does make me nervous somewhat, so basically I will aim to get $1 million by 35 and not be too greedy since by doing so I expose myself to more risk.

This concept is expressed in the saying, "If you reach for the stars, you'll fall harder." In the career world it is the reason why most parents try to get their children to become accountants or engineers when they grow up as oppose to movie stars. An accountant or engineer will get paid an average salary of maybe $60,000 a year, which is nothing compared to Tom Cruise's $20 million per movie, but how likely is one person going to be the next Tom Cruise compared to getting a job as an accountant or engineer? As John Bogle said, "The greatest enemy of a good plan is the dream of a perfect one."

I have a lot to do next year. I will switch from Hesta to Sunsuper to exploit lower fees. I will also think about gearing. However, I will take baby steps by maybe putting 5 per cent of my portfolio into a geared fund. When I feel comfortable with the taxes, fees, and so on, I may start to divert more of my savings into the geared fund. Virtually all the geared funds in Australia seem to be actively managed. This approach of having core low-cost investments in index funds and satellite investments in riskier investments is quite common and is known as the core-satellite approach to investment.

The core satellite investment strategy proves that indexing and active funds can comfortably sit side by side in a portfolio. Michael Houlihan, Vanguard's Retail Products and Technical Services Manager said: "Many of the large Australian superannuation funds currently use a 'core-satellite' investment strategy and we are seeing an increasing number of advisers applying this strategy to their client portfolios. The main benefit of this approach is that advisers can efficiently implement their asset allocation targets using low-cost index funds and alter the active fund exposure to achieve a desired risk/return profile."

Source: http://www.vanguard.com.au/.../indexdl_2290.aspx

One of the coolest financial innovations I have seen in America is the leveraged ETF. Proshares offers both leveraged ETFs and inverse ETFs. The former is designed to double the returns or losses of a particular index while the latter is designed to give the opposite. That is, if the index goes down, the ETF price goes up and vice versa. For example, the Ultra S&P500 ETF gives double (200%) the performance of the S&P500 index. I wish these products were available in Australia. I probably wouldn't use the inverse ETFs much but I would used the leveraged ETFs. The two can combine to form an inverse leveraged ETF, such as the UltraShort Dow30, which you can use to make money from a long position if you expect the Dow to go down.

ETFs on the ASX: Good or Bad?

ETFs are exchange traded funds. You can buy and sell them on the Australian Stock Exchange and they act like a mutual fund unit. In America the ETF market is highly developed, offering customers countless products. In Australia, however, the only ETFs I can think of are the country-specific ones offered by iShares, the Australian index ETFs by State Street Global Advisers, and GOLD.

I don't have any ETFs at the moment. The problem is that I only work part-time and if I dollar cost average (e.g. invest $500 per fortnight) then I will pay brokerage costs (costs of buying or selling shares). On online brokerage Commsec, you have to pay $20 for transactions less than $10,000. Most traditional mutual funds (not all) do not charge you anything to put money in. So why bother with ETFs at all? ETFs usually have very low management fees, lower than their mutual fund equivalents. For example, Vanguard Australian Shares Index Fund has an MER of 0.70 per cent while the SPDR ETF that tracks the ASX200 (ASX:STW) has an MER of 0.286 per cent. So basically using mathematics I am able to calculate that for the ETF to be worth it I would have to invest about $5,000 in one go for it to beat the Vanguard index fund given brokerage costs of $20 per transaction. In order for you to get the most bang for your buck you should invest $10,000 each time. A 0.70 per cent fee on that amount means you pay $70.00 per year. A 0.286 per cent fee plus $20 brokerage on $10,000 means you pay $48.60, which means you save $21.40 per $10,000 you invest if you use the ETF.

Obviously at this moment I don't have $10,000 or even $5,000 lying around, and so ETFs are not not practical for me. In order to save up that amount, I would have to wait for a long time. ETFs will be something I'll think about when (or if) I start earning more.

I have no interest in GOLD, so I won't talk about that. I will talk about the iShares ETFs. As a simple rule I aim to invest half in Australia and half outside Australia. Australia only makes up 2 per cent of the world economy, but I invest 50 per cent here because of currency worries. If I invested almost all my money overseas then fluctuations in the Australian dollar will have too much impact on investment returns. Vanguard and Hesta seem to believe the same thing. This is why I have been looking at the iShares ETFs because they provide a window into investing outside Australia. I am particularly interested in IVV, which tracks the U.S. S&P500 Index. It has an MER of 0.09 per cent! I think this must be because the American financial system is highly developed and thus they are able to get economies of scale going. Two ETFs provided by iShares that I think are a waste are IOO and IEU. IEU is the biggest waste. You pay an MER of 0.60 per cent to invest in European companies. IVE claims to track the MSCI EAFE Index (Europe, Australasia, and Far East). However, if you look carefully at the country makeup of IVE you'll notice that about 90 per cent of it is in European countries. So essentially IVE is a European ETF, yet its MER is 0.34 per cent. IOO invests in the top 100 companies in the world. The problem is that it is hardly global. About half of them are European and half are American, and the MER is 0.40 per cent. Why not buy half IVV (S&P500) and half IVE (EAFE) and pay a weight MER of 0.215 per cent?

The most expensive ETF provided by iShares is IEM, which invests in emerging markets. Emerging markets make up 40 per cent of the world economy now, so having some exposure I think is a good idea. The monopoly of Europe, America, and Japan may be a thing of the past. iShares has separate ETFs for emerging countries (IZZ invest in China with MER 0.74%, IKO in South Korea with MER 0.68%, and ITW in Taiwan with MER 0.68%). However, I think it's better to invest in IEM and get not only China (14.8% of IEM), South Korea (12.8% of IEM), and Taiwan (9.1% of IEM) but also other emerging countries like Russia, Brazil, and Mexico.

The developed Asian countries all seem to have similar MERs: IHK for Hong Kong with MER 0.52%, IJP for Japan with MER 0.52%, and ISG for Singapore with MER 0.51%.

Update 19/4/2008
My calculations may have been slightly wrong when I said that you need to invest $5000 at once for the Australian share ETF to beat Vanguard's Australian share mutual fund in terms of cost. The difference is that for the ETF the $20 brokerage is paid once and that's it. For Vanguard, the extra management fee is taken out every year for the rest of your life, not just for the first year. To calculate this then is much more complicated. I think I'll need to know how to find the present value of a perpetuity. Unfortunately I've forgotten how to do that. Nevertheless, intuitively this means that investing in ETFs is even more cost-effective than I thought. You probably only need to invest $1,000 or less at a time for its costs to be equal to the cost of the traditional mutual fund.