AIA Queensland Committee Member and Chermside Equities Group Convenor, Rod Fraser recently gave a presentation to the Brisbane AIA group on Exchange Traded Funds (ETFs). In Part 1 of the series, Fraser explained what are ETFs and how they work. In the second part, he provides us with a checklist of what you need to know before you invest.

1. Do you trust the Issuer?
   • Is the issuer a well-known provider that you can rely upon?
2. How much data and information is provided?
   • Is the fund completely transparent about its investments and strategy? Does it provide regular, monthly commentary that helps you to understand its asset allocation?
3. Who is the Custodian?Are the underlying assets real or synthetic?
   • Some funds invest in derivatives that track or hedge actual investments, these are known as synthetic
4. How is the index constructed?
   • Do you have confidence in the index provider and understand how it compares to your fund?
5. Liquidity of the fund?

   • The main concern I have is in the underlying holdings, not in the ETF itself as it is supported by the market makers. For example if there is a big correction, will the market makers have trouble selling the securities? I wouldn’t be concerned with an ETF than tracked the S&P 500 but if it is a concentrated ETF focused on a specific sector where securities aren’t traded very often, then the market markers may have to dump the securities and they may not be worth anything.

6. Liquidity of underlying assets
7. Fees
8. Buy sell spread
9. Fees

A Few ETF Examples

1. Vanguard Australian Shares Index ETF (ASX:VAS)

Source: Vanguard, as at 31 December 2021

Source: Market Index as at 7 February 2022

VAS Checklist

• Do you trust the Issuer? Yes
• How much data and information is provided? Plenty
• Who is the Custodian – JP Morgan Chase Bank, N.A. (Sydney branch)
• Is it synthetic or real – Real
• How is the index constructed? Well
• Liquidity of the fund – Good
• Liquidity of underlying assets – Good
• Buy sell spread – OK
• Fees – Low

2. VanEck MSCI International Quality ETF (ASX:QUAL)

The MSCI World ex Australia Quality Index is based on MSCI World ex Australia, its parent index, which includes large and mid cap stocks across 22 Developed Market (DM) countries*. The index aims to capture the performance of quality growth stocks by identifying stocks with high quality scores based on three main fundamental variables:

1. High return on equity (ROE)
2. Stable year over- year earnings growth
3. Low financial leverage

The MSCI Quality Indexes complement existing MSCI Factor Indexes and can provide an effective diversification role in a portfolio of factor strategies. Index calculation methodology

A four-step process is followed to determine the Index constituents:

1. The eligible universe of securities is defined as the securities in the Parent Index.
2. A quality score is calculated for each security in the universe based on the following fundamental variables: (a) return on equity; (b) earnings variability; and (c) debt to equity ratio. If all three variables are available, a quality score for each security is calculated based on the average scores for the three variables. If (a) is positive and (b) or (c) is unavailable, the quality score is calculated based on the two available variables. If (a) is positive but both (b) and (c) are unavailable, the security is ineligible for inclusion.
3. The securities are ranked by quality score and a fixed number required to cover 30% of the market capitalisation of the Parent Index rounded up to the nearest 25 are selected, with the aim of attaining a high exposure to the quality factor, while maintaining sufficient market capitalisation and number of securities coverage. Individual issuer weight is capped at 5%.
4. Securities eligible for inclusion are weighted as follows: quality weight = quality score x market capitalisation weight in the parent index

The Index is rebalanced on a semi-annual basis, usually as of the close of the last business day of May and November. The quality scores are recalculated at the end of April and October and used for May and November rebalances respectively. The updated Index is generally announced nine business days before the effective date.

QUAL Checklist

• Do you trust the Issuer? Yes
• How much data and information is provided? Plenty
• Who is the Custodian – State Street Australia Limited (‘State Street’)
• Is it synthetic or real – Real
• How is the index constructed? Well
• Liquidity of the fund – OK
• Liquidity of underlying assets – Good
• Buy sell spread – OK
• Fees High but OK

3. Van Eck Morningstar Wide Moat ETF (ASX:MOAT)

A focus on quality U.S. companies Morningstar believes possess sustainable competitive advantages, or “wide economic moats”. The ETF targets companies trading at attractive prices relative to Morningstar’s estimate of fair value.

The Morningstar Wide Moat Focus Index is a rules based index comprised of at least 40 attractively priced US wide-moats stocks, as determined by Morningstar’s time-tested proprietary research. According to Morningstar, wide-moat stocks are companies identified as having sustainable competitive advantages.

Index description: The Morningstar Wide Moat Focus NR AUD Index is a rules-based, equal-weighted index intended to offer exposure to attractively priced companies with sustainable competitive advantages according to Morningstar’s equity research team.

Fees and other costs management costs p.a. 0.49%.

Source: Van Eck as at 31 December 2021

MOAT Checklist

• Do you trust the Issuer? Yes
• How much data and information is provided? – Plenty
• Who is the Custodian – State Street Australia Limited (‘State Street’)
• Is it synthetic or real – Real
• How is the index constructed? GOOD
• Liquidity of the fund – Fair
• Liquidity of underlying assets – Good
• Buy sell spread – Fair
• Fees – High but OK

4. Perth Mint Gold (ASX:PMGOLD)

PMGOLD is designed to track the international price of gold in Australian dollars and offers investors a simple, low cost way to access the returns on gold. PMGOLD trades like a regular share and is purchased via a stock broking account.

Investments in PMGOLD are fully backed by physical bullion held by The Perth Mint, with metal stored on investors’ behalf guaranteed by the Government of Western Australia. PMGOLD units can be converted into gold holdings in a Perth Mint Depository account. Depository account holders can choose to take delivery of physical gold bars. Fees and charges apply.

PMGOLD has returned 8.35% per annum since it began in 2003 (as of 31 December, 2021). It offers a low management fee of 0.15% per annum.

PMGOLD Checklist

• Do you trust the Issuer? Yes
• How much data and information is provided? – Enough
• Who is the Custodian – Perth Mint (guaranteed by WA Govt)
• Is it synthetic or real – Real
• How is the index constructed? No index – the gold price in $A
• Liquidity of the fund – Fair
• Liquidity of underlying assets – High
• Buy sell spread – Fair
• Fees – Low

Note: The ETFs used in this note are for education purposes only and are not recommendations. Remember past performance is no guarantee of future returns.

For more information see What are ETFs and how do they work?