Discover SGX Securities: ETFs and ETNs

Dr. Clemen Chiang
Dr. Clemen Chiang

They may seem the same, but they aren’t — Exchange Traded Funds or ETFs, and Exchange Traded Notes or ETNs, are up next on Spiking’s bird’s eye view of securities available on the Singapore Exchange. We’ll be taking a look at what they are, what makes them different from each other, and what to look out for when considering them as investment options.

What are ETFs?

Exchange Traded Funds, as defined by Money Sense, are open-ended investment funds that are listed and traded on a stock exchange. A simplistic illustration of an ETF would be a group of kids putting their piggy bank change together to buy a single goody bag with different kinds of candy in it.

An ETF has an investment objective which is usually to give investors a return that tracks a certain index. Investors can buy units of an ETF and sell them as they would shares at the stock exchange. They receive capital gains if the unit prices become higher than the buying price, and dividends if the ETF they invested in is the dividend-paying kind.

SIAS says that the SGX continues to welcome ETF listings, for equities not just in Singapore but also in

  • India
  • North Asia
  • the United States
  • Eastern Europe
  • Latin America

There are also ETFs for commodities such as gold.

What are the advantages of ETFs?

Investing in ETFs is a good idea since, as Money Sense and SIAS point out:

  • They enable investors to diversify and participate in an index without having to buy the component stocks of that index. Diversification (which Spiking has discussed in a previous post) also helps spread risk.
  • They come with lower fees, because index-tracking ETFs are managed passively and are not meant to outperform the indices they are tracking.
  • They usually have no sales charge, although investors would still have to pay brokerage commissions and transfer taxes.
  • They are transparent and flexible, just like stocks, which means you can get information on prices and trade all trading day.
  • They give relevant exposure to a particular country or market, if it is a long, single country ETF (see “long stock index” below).

What are the different kinds of ETF?

There are several kinds of ETFs on the SGX, as presented by Money Sense and SIAS:

  • Long stock index, which tracks an index like the Straits Times Index, which is the key index for the country of Singapore
  • Inverse or short ETFs, which track a corresponding long index’s inverse performance. If the long index goes down by 2%, for example, the short and inverse indices should also go up by 2%.
  • Bonds, which track bond indices
  • Commodities, which track commodity indices

SIAS also adds that investors should be aware of the many different kinds of structures ETFs have. Some ETFs are more complex than others, which means they may not invest directly in the components which make up the indices they track.

What are the risks of investing in an ETF?

With the many different kinds of ETFs come different kinds of risks, as Money Sense describes. Some of these risks are specific to an ETF type while others apply to ETFs in general:

  • They are not principal-guaranteed. An investor could lose all or a large part of his investment in an ETN.
  • They are susceptible to market volatility. If the price performance of the index that the ETF is tracking fluctuates, the ETF price moves right along with it.
  • They don’t always keep up with the indices. For cash-based ETFs, the manager might not be able to make the necessary adjustments in the component stocks to match market changes simultaneously.
  • They come with foreign exchange risk if investors buy an ETF in a different currency, so it is best to check what currency an ETF trades in before investing.
  • They might be difficult to sell units of if the ETF’s liquidity drops, which might happen in extreme market conditions, or if the market maker assigned to ensure the ETF’s liquidity becomes insolvent.
  • They may not be suitable for long-term investment, as in the case of inverse or short ETFs, which are meant to track a long index on a daily basis.

SIAS likewise reminds investors of the importance of reading an ETF’s prospectus and other accompanying documents such as the product highlights and research reports. You should go over the investment objectives, exposure and expected returns extra carefully.

What is an ETN?

Exchange Traded Notes do have a few things in common in ETFs, as pointed out by Wiser Wealth Management — they both reduce risk and allow investors to diversify. They also both track indices, can be traded like stocks and have great liquidity.

But unlike ETFs, which are made up of stocks, bonds or commodities, an ETN is not made up of anything except a promise. Investors have nothing but the word of the ETN provider (which is usually a bank or a financial services company) that it will track a certain index, and that it will pay them an index return.

What are the pro’s and cons of ETNs?

Investing in an ETN does have its advantages, says Casey Smith of Wiser Wealth Management, the most salient of which is flexibility. Where an ETF isn’t always able to adjust and keep up with the index it is tracking, an ETN can match an index’s performance perfectly, as long as the ETN provider holds true to its promise to pay.

ETNs also make it easier to invest in certain markets or indices (such as those for commodities like oil) which are more difficult to manage if direct investments were made into them.

But if an ETN provider goes bankrupt, the investors will not get their money back. This is because an ETN is an unsecured debt instrument. In other words, an ETN is a lot like lending money to someone, and that someone gives you a promissory note that he will pay you back.

That said, when choosing an ETN to invest in, an investor would do well to check the ETN provider’s credit rating (examples of which are A or AA ratings from Standard & Poor’s). DBS Vickers Securities adds that investors should be aware that an ETN provider might suspend creations and redemptions if it does not want to add to the debt it already has on its balance sheet for the index that the ETN is tracking.

What can Spiking do for SGX investors?

Spiking keeps investors up to date with the action taking place at the SGX. It has direct access to disclosures made at the SGX, and sends them in real time to investors using the Spiking app. These disclosures include the buying and selling activities of more than 8,000 sophisticated SGX investors.

Armed with this information, investors will be able to make better-informed investment decisions that don’t rely on hearsay or speculation. For details on how you can get info on the latest stock spiking and other up-to-the-minute SGX updates, visit the Spiking app homepage now.