Amanda Morrall talks to Smartshares Sam Stanley about NZ's overlooked exchange traded funds, how they can be used to achieve savings goals and where the market is headed.

By Amanda Morrall

While both the demand for and value of exchange traded funds (ETFs) overseas continues to increase, New Zealand's ETF market, of which the NZX remains the sole trader, is conspicuous by its relative unpopularity.

Smartshares, a wholly owned subsidiary of sharemarket operator NZX, launched its first fund 16 years ago (SmartTENZ  a basket of shares mirroring the NZX 10 Index). Since then, it has introduced  SmartFONZ (NZX 50 Portfolio Fund), SmartMIDZ (NZX MidCap Index Fund), SmartMOZY (NZX Australian MidCap Index Fund) and SmartOZZY (NZX 20 Australian Leaders Index Fund).

Between the more than 14,000 unit holders invested in these funds, there is close to NZ$300 million under management. By comparison, New Zealanders had, as of August this year, NZ$106 billion invested in term deposits.

Sam Stanley, head of Smartshares, blames the relative lack of interest on poor marketing, a lack of distribution channels and also general ignorance, but is confident the domestic market for ETFs is set to take off in New Zealand. (For more on how to invest in international based ETFs using a New Zealand domiciled fund manager read this story by Amanda Morrall).

To tweak the investing public's interest, Smartshares is looking to expand its ETF market in 2013 to include a range of new offerings including a commodities fund (possibly focused on gold), a fixed interest fund, an Asian high yield fund and a global equities fund.

While ETFs here may not be able to compete with the low-cost fee offerings in the United States (last month investment house Charles Schwab lowered its fees on a select range of ETFs to 0.04%-0.06%, Stanley maintains they are still good value for investors.

Smartshares' range of ETFs charge between 0.60 and 0.75%. Although the investment fees in other managed funds are wide ranging, the average is around 1%, something Stanley is keen to point out.

"Someone trying to actively trade and outperform the market may be paying 1-2% so 0.60% is low cost.''

The fees charged by Smartshares are all inclusive covering brokerage, custodial charges and registry fees, notes Stanley.

Diversification is perhaps a stronger selling point for ETFs in New Zealand.

"It spreads the risk across a whole basket of stocks," said Stanley.

While investors in ETFs may miss out on the gains of one particular stock doubling in value (assuming that's where all their money was invested), they are also protected from big losses through an ETF because of the diversification component.

There are three points of entry into an ETF:  via a broker, a financial advisor or through Smartshares itself. The minimum investment amount is NZ$1,500.

Stanley cautions rookie investors against rushing into the market without the benefit of professional advice. He said the majority of investors tend to come into these funds through a financial advisor or a broker.

While ETFs may not appeal to the more aggressive and risk tolerant investors, their performance, relative to term deposits, is nothing to sneer at.

The following three case studies below, produced by Smartshares, show how investors with specific savings goals, would have fared with ETFs compared with term deposits or straight forward bond portfolios.

Savings goal example:

Sam is saving for a deposit on her first home. Her savings goal is NZ$40,000 in three years and she can afford to put aside NZ$1,000 a month. Sam is looking for the investment that will help her reach this goal fastest. She has considered two options:

	Opening a savings account at the bank paying 5.21% pa1 with interest compounding Investing in SmartTENZ2 through Smartshares or an NZX Advisor with dividends reinvested. Based on the performance of the NZSX 10 index over the last three years, we have assumed TENZ Smartshares would return 12.83% pa3.
	Year 1 (NZ$) Year 2 (NZ$) Year 3 (NZ$) Bank account $12,336 $25,315 $38,970 $12,819 $27,282 $43,601 Difference $483 $1,967 $4,631

¹ Based on Reserve Bank average six monthly term deposit rate for the past three years.
² Using actual historical returns of the TENZ (NZSX 10 Index Fund) over three years as reported by FundSource as at 30 April 2004. The returns are after tax and management fee but before brokerage which is usually 0.8 – 1.4%.
³ This example assumes that the full gross annual (i.e. before any applicable taxes) of the interest and the dividends received are reinvested. Any tax on these returns is ignored for the purposes of this example.

With a bank account Sam did not reach her target of NZ$40,000. With SmartTENZ Sam is NZ$4,631 ahead of where she would be if she used a bank savings account and has exceeded her NZ$40,000 savings target. This is a clear indication of the superior longer term performance of Smartshares over bank deposits.

Saving for retirement

Dave and Mandy are in their mid 50s. Their children have just left home and they want to build their retirement savings. They are weighing their options:

Reinvesting the rental income from their investment property (NZ$1,000 per month) into bank deposits or Smartshares

Selling their investment property which would net them NZ$200,000 to invest in bank deposits or Smartshares.

They'd like to retire in about five years and they need the best performing investment option to ensure they can live comfortably in retirement. The table below outlines the potential performance of their investment options. It assumes a bank account pays 5.43% pa¹ over five years with interest compounding, and SmartMIDZ posts a return based on the NZSX MidCap Gross Index return of 12.08% pa².

Rental income reinvested into either:	Year 1 (NZ$)	Year 2 (NZ$)	Year 3 (NZ$)	Year 4 (NZ$)	Year 5 (NZ$)
Bank deposits	$12,350	$25,371	$39,099	$53,572	$68,831
	$12,772	$27,086	$43,129	$61,111	$81,265
Difference	$422	$1,715	$4,030	$7,539	$12,434

Sale of investment property with NZ$200,000 reinvested into either:	Year 1 (NZ$)	Year 2 (NZ$)	Year 3 (NZ$)	Year 4 (NZ$)	Year 5 (NZ$)
Bank deposits	$210,860	$222,310	$234,381	$247,108	$260,526
	$224,160	$251,239	$281,588	$315,604	$353,729
Difference	$13,300	$28,929	$47,207	$68,496	$93,203

¹ Based on New Zealand Reserve Bank average six monthly term deposit rate over the last five years to 30 June 2004.
² Based on actual performance of the NZSX MidCap Gross Index (which SmartMIDZ tracks) for the five years to 30 June 2004.
³ This example assumes that the full gross annual (i.e. before any applicable taxes) of the interest and the dividends received are reinvested. Any tax on these returns is ignored for the purposes of this example.

The benefit of reinvesting the rental income in SmartMIDZ instead of bank deposits is startling with NZ$12,434 separating the two investment choices. The difference is even more pronounced when the sale of the investment property is reinvested into SmartMIDZ – leaving Dave and Mandy a whole NZ$93,203 better off over just five years!

Retirement savings goals

Sue and Bob are a retired couple with NZ$250,000 invested in bank term deposits. They wonder if the performance of their term deposits is truly maximising their investment return potential. They are considering switching their investment over to either bonds or Smartshares, with low fees and higher historical performance. They want their investment to generate an income to support them in the future.

They have an initial investment horizon of seven years. The table below presumes the bonds return the New Zealand average over the past seven years of 5.95% and SmartMIDZ returns an average 10.32%, based on the seven year historical performance of the NZSX MidCap Gross Index to 30 June 2004.

Annual passive income generated from investment of NZ$250,000

	Year 1 (NZ$)	Year 2 (NZ$)	Year 3 (NZ$)	Year 4 (NZ$)	Year 5 (NZ$)	Year 6 (NZ$)	Year 7 (NZ$)	Total (NZ$)
Bonds 1	$14,875	$14,875	$14,875	$14,875	$14,875	$14,875	$14,875	$104,125
2	$22,250	$22,837	$23,136	$23,439	$23,746	$24,057	$24,372	$163,837
Difference	$7,375	$7,962	$8,261	$8,564	$8,871	$9,182	$9,497	$59,712

¹
Based on the Reserve Bank average New Zealand one year bond rate over the seven years to 30 June 2004.
² Based on actual performance of the NZSX MidCap Gross Index (which MIDZ tracks) over the seven years to 30 June 2004.
³ This example assumes that the full gross annual (i.e. before any applicable taxes) of the interest and the dividends received are reinvested. Any tax on these returns is ignored for the purposes of this example.

After seven years Sue and Bob would have received only NZ$104,125 in income generated from investing in bonds versus NZ$163,837 with SmartMIDZ, a staggering difference of NZ$59,712. In addition to the difference in income generated, if Sue and Bob had chosen to invest in bonds they would still have NZ$250,000 at the end of seven years. If they had instead invested in SmartMIDZ, the value of their investment at the end of the seven years would have increased to NZ$273,846 – an extra NZ$23,846!