ETFs vs Unit Trusts - Choosing the right solution for investment success

Assets invested in exchange-traded funds (ETF) and similar products have hit the US $7 trillion milestone in August 2020, according to research firm ETFGI. With the greater buzz around passive investing, interest in ETFs has never been higher.

ETFs purportedly give better long term returns than unit trusts due to lower costs, diversification, and having a fixed investment mandate. While this is generally true for the larger ETFs, it may not apply to certain popular choices. Peter Oh (Co-Founder, The InvestQuest) and Sheng Shi Chiam (Personal Finance Lead, Endowus) covered these topics:

0:00 Introduction

08:50 How to choose an index/ indices, types of stock indices

14:59 How to select the best ETF or unit trust for yourself

17:26 Case study on China indices: why similar sounding index may give huge returns differences

22:47 QnA

27:06 ETF Selection Process: Total Expense Ratio, Bid-ask Spread and Counter-party risk

33:33 US Stocks and ETFs Estate duties consideration and Funds withholding tax consideration

40:00 Why passive investing may not be better than active investing

46:33 QnA Part 2

1:00:44 Why people invest in Leveraged ETFs and ETNs

1:04:12 Investing in the next hot ETF

1:13:23 Why risk parity, all-weather investment strategies are risky and unproven

1:17:31 ETF vs Unit trust ?which is the better way to invest

1:22:20 Investment framework for ETF and Unit trusts

1:24:00 QnA Part 3

Excerpts on ETF Investing vs Unit Trusts Investing

Is it possible to lose all the money invested in an index ETF? How can that happen? Is it possible for fraud and fund manager to take all the money (25:14)

Peter: It depends on the index ETF replication methodology. Typically synthetically replicated ETFs runs a risk of losing money from counterparty risk.

Sheng Shi: Traditional Fund Manager go through an audit process, be it synthetically replicated ETFs or physically replicated ETFs. These auditors will ensure that whatever is reported in the financial statements is reflected in the actual holdings of the funds. There is definitely a level of checks against fraud.

What type of ETFs should investor focus on? More tech weighted ETFs? (49:20)

Sheng Shi: When investors look towards investing in tech ETFs, it signals that they have a macroeconomic view that they believe will translate to higher returns. They may think that technology is the next game changer, traditional retail shopping investments will do poorly, and eventually technology stocks will outperform relative to broad-based index. It could be the case where these sentiments are already priced in into the tech stocks and consequently the tech ETFs.

Peter: The question may be asked from a more tactical perspective. Tech stocks and ETFs have rallied strongly since Co-VID19. With the positive sentiments from the vaccine, the tech rally has slowed down, while non-tech stocks have grown in pricing. In the short term, it is possible that tech stocks are tactically allocated to non-tech stocks.

Analysts view that over the next 10 years for S&P 500, growth will be low at 2 -3% p.a. growth and will be greatly different from the past 10 years. What is your view? (52:55)

Sheng Shi: Many analysts share this sentiment, including the late Jack Bogle who has a formula to predict future market returns. In his view, future market returns are the sum of earnings growth, dividend yield and change in PE ratio. With dividend yield at its lowest, it is difficult to expect long term market growth from sustained change in PE ratio, especially when PE ratio is at its highest.

I don't believe that I can have an accurate read on the market, and Jack Bogle and the analysts could be right or wrong over an extended period. I prefer to focus on things that are within my control, and that is having a consistent approach in investing, having global diversification (not just S&P 500), and keeping cost low.

Peter: We also have to look at the interest rate environment. In the past risk-free rate could be as high as 4%. If you get a expected return of 8% for the S&P 500, that is an equity risk premium of 4%. With risk free rates at close to 0% in the US now, an expected return of 4% of S&P 500 is attractive.

If I chose to invest with Endowus, how will the funds and exposure overlap with my current ETF investments, which is also exposed to the US/global market? (1:24:00)

Sheng Shi: Our investment philosophy relative to other roboadvisor is to have really broad-based exposure to global stock markets. Unlike other robo-advisors that may tactically allocate into specific sectors and geographies, we have exposure in up to 10,000 equities around the world. Inevitably, if you are investing in any form of equities there will be an overlap in exposure with your own investments.

Your Endowus and DIY portfolio will be naturally heavier in US and global markets because we have a geographical passive asset allocation so everything should be apportioned accordingly if you invested in a passive manner yourself.

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