Where to invest – Nairametry
This week we will review Exchange Traded Funds (ETFs) and Mutual Funds (MFs) issued by Nigeria, which SEC Nigeria defines as group schemes.
Why group plans?
I am a big fan of UCITS (ETF and FCP) because they offer investors the possibility of diversifying their portfolios by spreading risk at a lower cost than investing in individual stocks. Mutual funds and ETFs are almost the same, and they are both pools of managed funds that seek to invest according to a predefined objective. The objective may be geographic targeting, for example, investing only in companies operating in Nigeria, or targeting by asset class, for example, investing only in equities.
For example, suppose I want to invest in the US only, in the tech space in particular. In this case, I can buy Vanguard Information Technology (VGT). By owning the VGT, I have an index that tracks information technology companies like Apple, Microsoft, NVIDIA, and Visa.
What is the Difference Between ETFs and Mutual Funds
Exchange Traded Funds (ETFs) and Mutual Funds (MF) work very similarly because they are both group plans. The main difference between ETFs and MFs is that ETFs can be bought and sold during the trading day, while MFs can only be traded at the close of the business day. EFTs also have tax advantages with lower expense ratios. Figure 1 shows a diagram from etf.com on the major differentials.
Figure 1: Comparison of EFTs and Mutual Funds
Nigerian EFT and MF Industry Overview
In the first quarter of 2021, according to data from the Securities and Exchange Commission of Nigeria, Nigeria has 12 registered ETFs and 109 mutual funds covering asset classes of money market, stocks, real estate and commodities. . Some funds are “balanced” which means that investors have access to different asset classes within that fund. Other funds are “ethical”, which means that the selection of investments in the fund follows ethical or religious considerations, such as the absence of alcoholic beverage companies.
What are the rating criteria for ETFs and MFs?
MFs and ETFs are investment opportunities. Thus, we measure the return they pay back to investors as expressed in earnings, in particular the return on equity. I will also show the cost of this gain to the investor by showing the expense ratio of the fund.
Overview of ETFs in Nigeria as of February 28, 2021
There are 12 SEC-registered ETFs in Nigeria. 10 ETFs hold stocks, an EFT (Vertiva S&P Nigeria Sovereign Bond ETF) only holds bonds. An ETF (New Gold ETF) holds gold and bonds. As of February 28, the total value of ETF investments in Nigeria was N18.48 billion. The average expense ratio is 0.06%, with the Stanbic ETF 30 charging the highest fees at 0.29% and the New Gold ETF charging the lowest fees at 0.01%.
Figure 2: EFT classified according to change in net asset value
The New Gold ETF has the largest change in net asset values from January 2012 to February 2021. This increase in net asset value corresponds to an increase in the net asset value of gold in the portfolio from 8.2 billion naira to 11. 7 billion naira. Keep in mind that inflation in Nigeria increases, it makes the value of assets valued in USD appreciate. The New Gold ETF is therefore an asset class to be protected against inflation.
It is also important not to compare a bond fund to equity funds as the two are different and will meet the investment objectives of different investors. Bond funds are generally preferred when the objection is preservation of capital. In contrast, EFTs with a high equity content are selected when the objective is capital appreciation. However, it is instructive that the only listed bond ETF outperforms pure equity ETFs. The Vertiva Bond ETF tracks the FGN bonds issued. A quick look at the ETF’s assets shows a portfolio with the bulk of holdings still beating double-digit inflation in Nigeria.
Figure 3: Composition of the Vertiva S&P Nigeria Soverign Bond ETF
Overview of mutual funds in Nigeria as of May 31, 2021
Nigeria’s Securities and Exchange Commission has approximately 109 registered mutual funds. The bulk of mutual funds in Nigeria are fixed income funds of various maturities. These include money market funds, fixed income securities and bonds. Money market funds, which are short-term duration funds, have the largest number of subscribers, nearly 240,000. Total assets under management in the MF asset class are 1.3 trillion naira (May 31 2021).
Figure 4 shows market share to total net asset value of mutual funds in May 2021
Again, we’ll rank the funds in order of performance using return on earnings. The SEC calculates return on equity as total net income (or loss) divided by net asset value. With mutual funds, we will separate funds with an equity component and fixed income securities.
Figure 5: Ranking of fixed income mutual funds
Figure 6: Ranking of equity-based mutual funds
The returns of equity-based bond funds have broadly outperformed bond funds in terms of equity returns. MF shares as an asset class have not beaten inflation which was listed at 18.35. The MF market is also showing depth with ValuAlliance offering unlisted stocks as part of a total return target where it looks for undervalued securities traded at a low price for accounting.
The Nigerian equity market peaked at the end of January and remained below the 40k index line for most of the year after a strong start. The AIICO balanced fund, for example, had a return on equity of 11.85 in February 2021. See Figure 7 showing the NSE All-Share index.
Figure 7: Nigerian All Share YTD Index 2021
Again, it is crucial to compare only within asset classes and not between them; you compare fixed income with fixed income, not with variable income like stocks.
How to use MFs and ETFs
Group plans offer diversification at a lower cost. Suppose you have a longer time horizon and you can manage the risk, in this case equity funds can achieve this by offering a real rate of return. If you are investing in fixed income, match the maturities. If you have an investment horizon longer than 24 months, consider bonds. If your investment window is much shorter then money market funds should be your preference.
It is also essential to monitor expense ratios. The top performer in May in the Lead Balanced Funds equity category has a 10% charge rate. It is also important to find out from the managers whether they are offering dividend-reinvestment plans that will allow dividend composition. I always advise you to compound your returns by reinvesting dividends.