nvestors will soon have another investment alternative, with the imminent launch of ETF or

Exchange Traded Funds. Earlier this year, the Philippine Stock Exchange (PSE) approved the
guidelines governing ETFs and last week, a public forum was held introducing ETFs to the
public.
We previously wrote about the basics of ETF investing here, but here are additional details about
this new investment product to help investors decide whether ETFs are fit for them.
What are Exchange Traded Funds (ETF)?
An ETF is a managed investment fund that tracks an index or a basket of assets and is traded on
an exchange such as the Philippine Stock Exchange. For clarity, lets break down this definition.
Managed Fund
As a managed investment fund, an ETF is similar to mutual funds and unit investment trust funds
wherein they are managed by a group of investment managers in the financial institution offering
the ETF. The role of the ETF fund managers is to track an index or a basket of assets. We
discussed in detail the difference of ETFs vs. mutual funds and UITFs in this article.
Tracking an Index
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The index that the ETF may track may be any asset index. Initially, this could be the Philippine
Stock Exchange index (PSEi), the primary equity index in the Philippines comprised of 30
publicly traded companies in the PSE. By tracking the index, ETFs are supposed to replicate
the performance of the index, hence, ETFs are expected to produce a similar level of return.
ETFs are rarely traded actively, meaning, they are not designed to consistently beat the index. It
can then be expected that the returns of ETFs may be somewhat lower compared to the actual
performance of the index. That may partly be due to imperfect rebalancing of the index and
transaction costs with regard to the trades of the fund.
Traded on the Exchange
The main difference of ETFs versus other managed funds is that ETFs are traded on the
exchange, hence the name. Mutual funds and UITFs have end-of-day values called the Net
Asset Value per Share (NAVPS) in the case of mutual funds and Net Asset Value per Unit
(NAVPU) in the case of UITFs. These are the prices wherein an investor can purchase or redeem
shares or units of these funds. They can only purchase or redeem at the end of the trading day.
ETF, meanehil, is similar to stocks in the sense that its price may vary anytime during the trading
day. Since they are traded, investors may buy or sell those ETFs within the day. As per the
approved PSE guidelines, ETFs are supposed to issue a real-time value of the fund, to be called

the iNav, every fifteen (15) seconds. Hence, investors can know the value of the ETF in real-time
and can make decisions (like buy or sell) anytime during the day.
Benefits of ETF Investing
The primary benefit of ETF is diversification. ETFs offer another alternative to those looking for
more investment options aside from stocks, bonds, mutual funds or UITFs. Because of
diversification, investors may lower the risk of their overall portfolio since they can spread the
risk among all investment assets in their portfolio.
For example, if an investor is directly and fully invested in one stock and that stock tumbled in
price, the investor stands to lose a certain amount of money. But if the investor is 50% invested
in that stock and 50% invested in an ETF, the amount of loss may be lower because the ETF will
have a different performance from the stock. That is what is meant by reducing the portfolio
risk.
ETF investors may also benefit from higher income through speculative trading. Like stocks,
ETFs will be traded daily and prices may change anytime during the day. This gives traders an
opportunity to buy or sell an ETF within the day in the hopes of locking in gains due to
constant price movements. Traders may also speculate, because if they believe the index or the
assets comprising the basket may rise in the future, they can time the market and buy supposedly
at a low and sell the ETF later at a higher price.
Another benefit of ETF investing would be the ability to invest in a variety of assets at lower
investment cost. No actual ETF product has been launched to the market yet but we expect ETF
prices to be initially priced just a few thousand pesos. This makes it easier and cheaper for retail
investors to indirectly invest in a variety of assets or stocks.
For example, an investor currently has to shell out around P15,000 just to buy the minimum
number of shares of PLDT (stock code: TEL) and around P7,500 in order to buy the minimum
shares of Globe Telecom (stock code: GLO). This means, investors already must spend P22,500
just to invest in those two stocks. With ETFs, they can spend P22,500 to indirectly invest in all
the underlying assets included in the ETF. If the ETF is tracking the PSEi, ETF investors become
indirect investors the 30 companies comprising the index. Thus they get to reap the benefits of
investing in all those stocks at a lower cost.
Disadvantages of ETF Investing
In the same way that diversification can lower the overall risk of the portfolio, diversification
also tempers the overall return of the investor. For example, if an investor is fully invested in a
stock that rose 50% in price, the investor gets to receive the full 50% benefit. In ETFs, if that
stock is just one of several stocks being tracked by the index, the return will be lower than 50%
because other stocks in that index that underperformed will lower the overall return of the index.
Also, the intraday trading nature of ETFs may not be applicable to long-term investors. Longterm investors with an investment horizon of at least 5-10 years may find the daily prices of

ETFs volatile which could lead them to buying and selling ETFs in the short-term, thereby
distorting their overall investment objective and strategy.
This volatility in ETF prices may be caused not by fluctuations in the index performance but by
speculation and manipulation by a few players hoping to profit from intraday price changes. This
could also lead to a wide disparity between the actual index performance and ETF prices. Thus,
long-term investors who would simply leave money for some time and who would not trade
actively may find blue chip stocks or index mutual funds or UITFs instead to be better suited to
their investment objective.
When can we start investing in ETFs?
Probably very soon. Large local financial institutions such as Bank of the Philippine Islands
(BPI), Banco de Oro (BDO) and First Metro Investment Securities (FMIC) have disclosed that
they are interested to launch ETFs soon. The guidelines have already been approved and released
by the PSE, so we can expect now that interested players are now starting to prepare the launch
of their ETFs.

The Philippine Stock Exchange (PSE) has recently announced that Exchange Traded Funds
(ETF) will soon be launched to the market and ultimately listed and traded in the local bourse.
Here at PinoyMoneyTalk, we welcome this new development since we believe ETFs provide
investors with more avenues for investment, on top of current alternatives such
as stocks, bonds, mutual funds and UITFs, among others.
Before we all jump at this opportunity, lets first find time to understand what this new
investment asset really is.
What are Exchange Traded Funds?
Exchange Traded Funds or ETFs are open-end investment company that tracks a basket of assets
and traded on a stock exchange.
What does it mean by open-end investment company?
As an open-end investment company, an ETF can issue and redeem shares to the public
anytime. In contrast, a closed-end investment company has a fixed amount of shares available
to the public and, once fully subscribed, new investors can only purchase shares, not from the
company anymore, but from other investors. The open-end characteristic of an ETF makes it
more liquid and, as such, can be easily converted to cash with a known market price.
What does it mean by tracking a basket of assets?

The basket of assets refer to an index, a benchmark figure used to describe the overall
performance of a market. In the Philippines, the commonly used index or basket of assets is
the Philippine Stock Exchange index (PSEi), a basket of 30 PSE-traded companies that
describes the general performance of all Philippine stocks and, ultimately, the Philippine
economy. As of September 2012, the PSEi is composed of these 30 companies.
By tracking the index, an ETF utilizes a passive trading strategy in which its ultimate goal is
merely to mirror the performance of the index. For example, the PSEi ended the year 2012 with
a 32.95% growth. An ETF that tracks the PSEi would try its best to achieve that same
performance, although, of course, it would not be surprising if a slight variance occurs. Rarely
would an ETF beat the benchmark index since ETFs are not usually actively managed, that is,
they are not designed to beat the performance of the index.
Whats the difference between a stock and an ETF?
When an investor buys a stock, he or she invests in that company and expects to profit from the
growth of that company. Investors of ETFs also expect to profit from similar growth of
underlying companies included in the index, but they are more diversified since there are more
companies included in the index.
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This diversification strategy is a two-edged sword. If one company is growing profitably, direct
investors would also profit hugely from the investment. In the case of an ETF investment,
however, even if one company grows exponentially, if another company in that index is
underperforming, the income from the ETF will be tempered.
In cases of severe downturns, meanwhile, a direct investor of one losing company would suffer
from stock price declines. An ETF tracking a diversified index, on the other hand, would
minimize its losses because of the diversification strategy.
In terms of liquidity and tradeability, stocks and ETFs are very much alike. Both instruments can
be easily bought and sold in the exchange during trading hours. They can both be traded between
or among investors, without the participation anymore of the ETF issuer.
Although ETFs will have its Net Asset Value per Share (NAVPS) at the end of every day, the
price at which an ETF may be bought or sold may differ and, like stocks, this price depends on
the expectation of the investor in the future cashflow of the basket of assets comprising the ETF.
Whats the difference between ETFs and Mutual Funds/UITFs?
Mutual funds and unit investment trust funds (UITF) are still slightly different with one
another (see Comparison of Mutual Fund vs. UITF), but they both refer to a collective scheme
that pools investments from the public to invest in various asset classes.
ETFs are similar in the sense that they collect investments but, instead of actively trading to beat
the index as in mutual funds or UITFs, the money is invested to track the performance of an

index. (It should be noted, though, that some mutual funds and UITFs now are designed to track
the PSE index.) It can then be expected that ETFs will have similar or slightly lower returns than
the tracked index. Rarely, though, will an ETF have higher returns, unless the fund is actively
traded.
In terms of pricing, ETFs, mutual funds and UITFs all have end-of-day NAV, representing the
Net Asset Value of all underlying securities owned by the fund. Mutual funds and UITFs are
required to disclose their NAVs at the end of the trading day.
In the case of ETFs, meanwhile, the PSE additionally requires them to disclose the iNAV every
fifteen (15) seconds during any given trading day. The iNav is an approximation of the current
value of the basket of securities on a per share basis. This supposedly tells investors the real-time
value of their ETF investment in order for them to have an idea of the current market price of
their ETF. This is the guiding price that ETF investors can use to consummate a buying or selling
transaction on the exchange.
What are the listing requirements for ETF companies?
In the draft ETF rules issued by the PSE, an ETF applying to list must have a minimum paid-up
capital of at least P250 million. The ETF company may offer its securities to the public upon
approval of listing application, but will not be covered by the IPO listing rules of the PSE. The
lock-up and track record requirements in the IPO listing rules will also not apply.
In terms of the index that the ETF endeavors to track, the PSE requires that underlying securities
comprising the index must be listed and traded in a registered exchange and have sufficient
liquidity. The ETF shall also disclose the liquidity criteria and methodology in the Fund
Prospectus that will be available publicly.
What are the continuing listing requirements for ETF companies?
Like regular minimum public ownership rules, ETFs are required to maintain public ownership
of at least 10% of its issued and outstanding shares.
The ETF must also have an Investor Relations Office whose role it to manage the funds investor
relations program and provide facilities for investors to exercise their rights. Also, the general
structured and unstructured reportorial requirements shall apply to ETFs under the Disclosure
Rules of the PSE in addition to the reportorial requirements under the Securities and Exchange
Commission ETF Rules.
When can we start trading and investing in ETFs?
The PSE has recently finished receiving public feedback on its draft ETF rules. We can then
expect the PSE to finalize and approve the rules in the coming weeks. As per the PSE timeline,
ETFs should be available to the public within the 1st quarter of 2013, that is either in February or
March this year. Lets see if this indeed pushes through in the coming 1-2 months.

The two ETFs to look at are iShares MSCI Philippines (EPHE) and PowerShares DWA
Emerging Markets Momentum Portfolio ETF (PIE).
Advantages
There are numerous advantages of mutual funds and ETFs. Below are a few:
Diversification
One ETF can give exposure to a group of equities, market segments or styles. In comparison to a
stock, the ETF can track a broader range of stocks, or even attempt to mimic the returns of a
country or a group of countries. For example, you could focus on Brazil, Russia, India and China
in a BRIC ETF. Mutual funds can be diversified as well, but the ETF has lower fees and trades
more like an equity investment.
Lower Fees Compared to Managed Funds
ETFs, which are passively managed, have much lower expense ratios compared to other
managed funds. A mutual fund's expense ratio is usually higher due to costs such as: a
management fee, shareholder accounting expenses at the fund level, service fees like marketing,
paying a board of directors, and load fees for sale and distribution.
Trades Like a Stock
Although the ETF might give the holder the benefits of diversification, it still trades like a stock.

ETFs can be purchased on margin and sold short.

They trade at a price that is updated throughout the day. An open-ended mutual fund is
priced at the end of the day at the net asset value.

ETFs also allow you to manage risk by trading futures and option just like a stock.

Because they trade like a stock you can quickly look up the approximate daily change of
a commodity or sector with the ticker symbol of a tracking ETF. Many stock websites
also have better interfaces for manipulating charts than commodity websites and even
provide applications for your mobile devices.

Dividends Are Reinvested Immediately

The dividends of the companies in an open-ended ETF are reinvested immediately, but the
timing can vary for index mutual funds. It should be noted that dividends in unit investment trust
ETFs are not automatically reinvested, thus creating a dividend drag.
Capital Gains Tax Exposure Is Limited
ETFs can be more tax-efficient than mutual funds because most of the tax on capital gains is paid
on sale and completely up to the investor. Even if the ETF sells or buys shares while attempting
to mimic the basket of shares it is tracking. This is because the capital gains from in-kind

transfers, seen in ETFs, do not result in a tax charge, and therefore can be expected to be lower
compared to mutual funds.
Mutual funds, on the other hand, are required to distribute capital gains to shareholders if the
manager sells securities for a profit. This distribution amount is made according to the proportion
of the holders' investment and taxable as a capital gain. If other mutual fund holders sell before
the date of record, the remaining holders divide up the capital gain, and thus pay taxes even if the
fund overall went down in value.
Lower Discount or Premium in Price
There is a lower chance of having ETF prices that are higher or lower than the actual value.
ETFs trade throughout the day at a price close to the price of the underlying securities, so if the
price is significantly higher or lower than the net asset value, arbitrage will bring the price back
in line. This is different than closed-ended index funds because ETFs trade based on supply and
demand and market makers will capture price discrepancy profits.
Disadvantages
May Be Limited to Larger Companies
In some countries, investors might be limited to large-cap stocks due to a narrow group of stocks
in the market index. Only including larger stocks will limit the available exposure to mid- and
small-cap companies. This could leave potential growth opportunities out of the reach of ETF
investors.
Intraday Pricing Might Be Overkill
Longer-term investors could have a time horizon of 10 to 15 years, so they may not benefit from
the intraday pricing changes. Some investors may trade more due to these lagged swings in
hourly price. A high swing over a couple hours could induce a trade where pricing at the end of
the day could keep irrational fears from distorting an investment objective.
Bid-Ask Spread Can Be Large
As more niche ETFs are created you might actually find an investment in a low volume index.
This could result in a high bid/ask spread. You might find a better price investing in the actual
stocks (usually large institutional investors) or maybe even a managed fund.
Costs Could Actually Be Higher
Most people compare trading ETFs with trading other pools of stocks, such as mutual funds, but
if you compare ETFs to investing in a specific stock, then the costs are higher. The actual
commission paid to the broker might be the same, but there is no management fee for a stock.
Dividend Yields
There are dividend-paying ETFs, but the yields may not be as high as owning a high-yielding
stock or group of stocks. The risks associated with owning ETFs are usually lower, but if an
investor can take on the risk, then the dividend yields can be much higher. For example, you can
pick the stock with the highest dividend yield, but ETFs track a broader market, so the overall
yield will average out to be lower.

Leveraged ETF Returns

Certain ETFs, which are double or triple leveraged, could result in losing more than double or
triple the tracked index. These types of speculative investments need to be carefully evaluated. If
the ETF is held for greater than one day, the actual loss could be more than double or triple. For
instance, if you own a double leverage natural gas ETF, a 1% change in the price of natural gas
should result in a 2% change in the ETF on a daily basis.

The bid price represents the maximum price that a buyer or buyers are willing to
pay for a security. The ask price represents the minimum price that a seller or
sellers are willing to receive for the security.

The ask price is what sellers are willing to take for it. If you are selling a stock, you
are going to get the bid price, if you are buying a stock you are going to get the
ask price. The difference (or "spread") goes to the broker/specialist that handles
the transaction.