Stock takes: Huge growth in passive trackers

Aaron Jenkins, NZX Head of Funds Management. Photo / File

Exchange traded funds, or ETF's, have enjoyed explosive growth around the world and New Zealand has proven no exception.

An ETF is a marketable security that tracks an index, a commodity, bonds, or a basket of assets, and trades like a common stock on a stock exchange.

Investors like them because they are simple and cost-effective. There are also potential tax advantages as they are treated as a portfolio investment entity (PIE) by the IRD.

In 2016, the NZX's Smartshares ETFs, which are quoted on the exchange's main board, experienced a big uptake in the number of direct retail applications - up 177 per cent on the previous year - while on-market trading increased by 72 per cent on 2015.

So far this year Smartshares ETF applications are up by more than 300 per cent on the prior period, the exchange says.

Smartshares ETFs appeal to a wide range of investors, with more than 17,500 direct unit holders, who have $1.8 billion invested.

Aaron Jenkins, NZX Head of Funds Management, who oversees the Smartshares business, noted the rise and rise of ETF's offshore.

"We are seeing that interest here as well as people move away from high-cost, active funds and move into low-cost, passive, index-based funds," he said.

Perhaps the simplest of the Smartshares funds is the top 10, now 21 years old, which invests in the top 10 stocks in proportion to their market capitalisation.

"Our view is that over time, the majority of active style investors can't beat the index," Jenkins says.

The number of ETFs available has mushroomed from five, two and a half years ago to 23 today.

ETF SKEW

But EFTs have some high profile detractors. Carl Icahn, the legendary US billionaire and investor activist, doesn't like them, telling CNBC last year that there was a "dangerous amount of money dammed up in ETFs".

Exchange traded funds worldwide have attracted the biggest inflow of money in the first two months of the year on record, heightening concerns that ETF buying is fuelling an unsustainable price bubble in the US stock market, according to London's Financial Times.

STOCK PICKERS

Naturally enough, the people whose job it is to pick winners are not overly enamoured with ETFs.

Their view holds that a large, perhaps badly run and highly indebted stock could conceivably have a big weighting on an index, thereby skewing the pitch.

Nevertheless, Matt Goodson, managing director at Salt Funds Management, said ETFs have their place.

"The negative of ETFs is that the weighting of a stock within an ETF is determined by its scale rather than any other factor, so it creates a number of potential issues," he said.

Goodson said ETFs can create anomalies in stock valuations, particularly when companies are on the cusp of either entering, or exiting, an index.

"As ETFs become ever larger, and if there is then a market shock, then there is potential for ETF redemptions to magnify the effects of a pullback," he said.

In New Zealand, the market has a combination of being a high dividend-yield market, coupled with high average price/earnings ratios - an unusual combination by world standards.

"We suspect the reasons for that is the presence of some of our biggest companies in some of global dividend-based ETFs," he said.

Goodson says that while the presence of local ETFs on the market was still relatively small, the offshore ETFs can influence prices here.

"It's still early days for ETFs in New Zealand," he said. "The bigger effect is not from homegrown ETFs, which are relatively small. It's really the global ETFs, which have large holdings in this market," he said.

COMVITA STING

Comvita has had a rollercoaster ride over the last few months on the back of a poor honey harvest and trouble in the unofficial trading channels into China.

The stock traded today at $6.85, down from $8.60 just before this week's earnings downgrade.

The company said the two major downside risks communicated earlier to the market - the impact of bad weather on the harvest and pressure on informal trade channels into China - had both come to bear.

"We now expect that the direct impact of these two situations will result in an after tax operating loss for the financial year ended 30 June 2017, in the order of $7 million," it said.

Comvita, on the back of intense interest in the manuka honey sector, hit a record high of $12.87 last May.

NZME GAIN

Shares in NZME, publisher of the New Zealand Herald, have risen sharply since late last year.

The stock traded this week at 95c after bottoming out at 49c last November. The shares, upon de-merging from the Australian parent in June, debuted on the NZX at 85c.

NZME and its potential merger partner, Fairfax NZ, said the Commerce Commission had advised that it had further extended the target date for the NZCC's final decision on the proposed merger of the two businesses to May 2, 2017.

In February NZME, which also owns Newstalk ZB and a suite of entertainment radio brands including ZM and The Hits, said it made a trading ebitda (earnings before interest, tax, depreciation and amortisation) of $71.9m, up slightly from $71.8m the previous year.