I’ve said before that I pray that more Filipinos become moderate investors, even if most of them are conservative now. A good way to become a moderate investor is by educating yourself on the different investment instruments, and distributing your investments across them.

One investment instrument that gets a lot of attention is “pooled funds”, in which you join a “pool” of other investors, and a fund manager handles the whole pool of money depending on the objectives of the fund. Mutual funds and UITFs fall under this category.

But there’s a relatively recent addition to this category: ETFs, or exchange traded funds. ETFs became available in the US in 1993, Europe in 1999, and the Philippines in 2013. While there are many types of ETFs available in more advanced markets, they haven’t made a big splash here yet. I’ve been getting a few questions about ETFs, so I’ve put together a basic guide here so you can learn more about them.

What are ETFs?

An exchange traded fund is an investment fund that’s traded like a stock. There are lots of kinds of ETFs; some of them track foreign stock market indices, specific sectors like energy or oil, or commodities.

But the most basic type of ETF simply tracks a benchmark index to match its performance. So if an equity index ETF is tracking the Philippine Stock Exchange index, its underlying securities would consist of stocks like Ayala Land, SM Investments Corporation, PLDT, BPI, and so on, much like an equity mutual fund or UITF.

In short, think of an ETF as a mutual fund that you can buy and sell on the stock market. And because ETFs are traded like common stocks, they don’t have a NAVpu or NAVps like UITFs or mutual funds; their share prices change throughout the day as the market trades.

Basically, you get the diversification of a mutual fund with the flexibility of stock trading combined in an ETF.

What are the pros and cons of ETFs?

Pros:

• Cheaper diversification. Buying into just one ETF gives you exposure to a whole group of equities, meaning you don’t have to buy each individual stock yourself. So for a small amount of money, you can have a diversified portfolio. Anybody who can buy the minimum board lot can therefore participate in the growth of the Philippine economy. And ETFs are transparent about their structure; you can just visit their site and see the underlying securities that make up the fund (and in what percentage).
• Can cost less than actively managed funds. Mutual funds charge management fees of around 2%. UITFs can have trust fees of 0.20% to 1.50% per year. With buying and selling stocks, your costs will be lower. This is because an ETF is passively managed, meaning you’re not paying a fund manager for his services; you’re just paying brokerage fees.
  • Here’s an example to make things clearer. If you invest Php 50,000 in a UITF, you’d pay up to P750 (1.50%) in fees. (There may also be fees for early redemption.) Compare that to the total trading costs of buying Php 50,000 worth of an ETF on the PSE, which is P147, and P397.50 when selling. These small differences add up to a lot, so ETFs can be cheaper cost-wise in the long run.

Cons:

• Can’t beat the market. Because an ETF is designed to track an index, its aim is not to beat it, but just to match it. So if you were looking for investments to beat the PSE, you’d be better off with actively managed funds that seek to beat the index. You’re well diversified when you buy into an ETF, but remember: diversification limits your losses, but it also limits your gains.
• Can cost more than other pooled funds. If you like to invest small amounts regularly, like Php 10,000 each month, you’ll get charged for every transaction when you buy into an ETF. If small, regular investment is your strategy, you may be better off with a mutual fund or UITF that doesn’t charge you transaction fees each time, which can reduce your returns.

What options are available to the Filipino wanting to invest in ETFs?

Unfortunately, you don’t have a lot of choice in the Philippine market yet. So far, the only ETF here is the First Metro First Metro Philippine Equity Exchange-Traded Fund (First Metro ETF), an equity index ETF which started in December 2013. Other banks such as BPI and BDO have expressed an interest in launching their own ETFs, but they are still considering tax rules and regulations, as well as market appetites, before they do so.

Are ETFs for you?

The answer really depends on your investment goals and risk tolerance. If you can’t tolerate volatility with your money, equity-based ETFs may not be for you. But if you have an eye on the long-term and can take the risk, consider including ETFs in your investment plan. ETFs are still pretty new to the Philippines, so keep an eye out for more ETF options in the future.

I hope this guide has given you the basics about this new asset class that you can add to your portfolio. But before you jump in, remember this quotation from Warren Buffett: “Never test the depth of river with both feet.” Educate yourself on the risks, and you’ll make the best decisions with your investments.

Always remember to invest according to your investment objectives, time frame, risk tolerance and don’t forget to diversify properly.

Here’s a great learning event for the Cebuanos as we bring Money Talks to Cebu this April 25, 2015.

Joining me in this life-changing event are my friends MARVIN GERMO, RFP and PAULO TIBIG.

Marvin Germo, RFP is known as “Mr. Stock Smarts” and he is one of the country’s most sought after speaker and trainer in the arena of stock market investing. Learn the foundations of proper stock market investing properly from Marvin. He is the author of 2 best-selling books on stock market investing, a columnist for Rappler and Business Mirror and a resident finance expert in 94.7 Mellow FM.

Paulo Tibig has earned the monicker “EntrepChamp” as he conducts hundreds of talks all over the nation on entrepreneurship. He is the CEO of one of the country’s largest logistics company, V Cargo and a former President of the Association of FIlipino Franchisers Inc. (AFFI).  He has authored a best-selling book on entrepreneurship.

I will be discussing the fundamental steps to achieve wealth as well as the proper foundations towards investing.

To register, click HERE or send an email to [email protected]

For a learning fee of only P800,00, this is an event every Cebuano shouldn’t miss!

QUESTION: I am ready to start investing and I would like to invest in equities. Is it better to invest in stocks directly or through pooled stock funds like UITF or mutual funds? —Name withheld per request, asked via e-mail

Answer: As a financial and investment planner, we need to subscribe to the principle of suitability. Without sufficient information, it wouldn’t be prudent of me to categorically say one would be better than the other. The answer really depends on you—if you are knowledgeable enough to select your own stocks, size of funds, and if you have enough time for investing.

However, to help you make a more informed decision, let’s discuss the advantages and disadvantages of both types of investing.

On individual stocks

Advantages :

Control—Buying your stocks directly gives you control over what and when to buy or sell.

Residual income—If you buy a stock with a good dividend payout, then you don’t have to watch the price movement anymore. As long as the company is earning and declares dividends, you will get dividends.

Maximized returns—individual stocks that are growing may beat the market and can give you better-than-average returns. Many stocks beat the index last year.

Potentially better returns—with proper selection and assuming that you are very good at selecting market performers, the growth of your own stock portfolio can outperform the stock market index and many stock funds.

Fees—buying your stocks directly from brokers usually means lower fees as fund managers charge a higher investment management fee compared to stock brokers.

Disadvantages :

Time-consuming—before investing, you should spend enough time thoroughly understanding how stock market investing works. You should also accumulate enough knowledge of both fundamental and technical analysis.  Fundamental analysis means you must be able to read and understand financial reports of the companies you would like to invest in, the general condition of the industries and market trends to which these companies belong to, general knowledge of macroeconomics and even the management of the corporations you would like to own shares of, etc. Technical analysis will require you to constantly study charts on price averages, trading volumes and a multitude of technical market theories like Dow theory, Relative Strength Index, Elliott Wave theory and more. While fundamental and technical analysis is not rocket science, it takes considerable time for you to learn them properly. Enrolling in a class like Marvin Germo’s Stock Smarts is a good way to start.

Diversification—all investment professionals will always recommend you to diversify. No amount of study and good performance in the past will guarantee the performance of a particular stock in the future so having several and properly selected stocks is always a prudent thing to do. Unless you have a very big capital for investing, you will be limited to the variety of stocks you can carry in your portfolio.

On stock funds

Advantages :

Professional fund management—this is perhaps the biggest advantage of pooled funds like UITFs and mutual funds. There is a dedicated team of investment experts that looks at investment opportunities and is investing the money according to the investment objectives of the fund. It is common to see CFAs or Certified Financial Analysts leading or being part of these investment teams. Good fund managers are clinical and logical investors and are not easily swayed by emotions as compared to individual investors.

Capital requirements—most of pooled stock funds have low capital entry requirements. One can invest in a fund for as low as P 5,000 to P10,000, with other providers requiring a monthly contribution of as low as P1,000 per month.

Diversification—all stock funds carry well-diversified stocks in their portfolio, usually blue chip or premium stocks. Since these are pooled funds, there are economies of scale in place; fund managers will be able to purchase different shares. Proper diversification will ultimately result in reduced portfolio risk.

Disadvantages :

Fees—While not all stock funds charge the same range of fees, these fees are usually much more than broker fees as there are costs involved in managing funds. Some funds even charges entry and exit fees, which can reduce the returns of your investments. Some funds are being sold through agents and advisors and commissions would need to be paid to them.

Control—you have no say on which funds you want or don’t want in your fund as this is already delegated to the fund managers. You also can’t modify the weight of the stocks inside a stock fund as fund managers follow maximum exposure limits per stock to ensure proper risk management practices. Even if you want more PLDT or Jollibee shares in your portfolio, your fund will only have a limited exposure to said stocks, like 10 percent.

The answer to your question is dependent upon you knowing the pros and cons of individual stock investing or through a pooled equity or stock fund. If you are a new investor, I recommend you invest in a stock fund first and as you get to understand how the stock market works and develop your competency in investing, you may want to start investing in individual stocks. There are no perfect investments and there are many ways to build your wealth, chose a strategy that you will be most comfortable with.

Do not forget, whether investing in stocks by yourself or through a fund, it pays to invest first in investment education.