Understanding Investment Performance Reporting

30 March 2023 Igor Rodionov

In The ETF Investor podcast, Nerina Visser hosted founder of ADVICEment, Igor Rodionov. The pair spoke about understanding investment perofmance reporting in detail.

ADVICEment uses algorithms to generate dynamic PDFs which contain calculations, dynamic text, tables, and charts. This speciality lends itself well to investment performance reporting and ADVICEment produces dynamic PDFs such as performance reports, minimum disclosure documents, general investor statements, institutional reports and market commentaries for their clients.

The podcast and the preliminary notes can be seen below.

The ETF Investor: Expisode 24 - WTF: What the Factsheet!

Nerina Visser (NV): Welcome to another episode of the podcast series – The ETF Investor – brought to you by the ETF Specialists, etfSA.co.za. My name is Nerina Visser, and I am your host. Through this podcast series we bring you insight and understanding of ETFs – Exchange-Traded Funds, clarity on how to best use it in any type of investment portfolio, technical details of what happens inside the ETF, and practical advice on how to choose ETFs for your investment wants and needs.

NV: Investors are often told to “do your homework”, to “understand what you invest in before you do so”, or even just “do your own research”, but what exactly does that mean, and how should ETF investors evaluate an ETF to decide if it’s right for you? In today’s episode we take a closer look at fact sheets, also called Minimum Disclosure Documents in regulatory speak. What should an ETF investor look out for when reading an ETF fact sheet? What information is important to help guide your investment decision, and what may well be a distraction on your journey to investment success? I have invited Igor Rodionov, founder of Advicement Investment Services, who produces such fact sheets, as my guest to help us make sense of W-T-F What The Factsheet. Welcome Igor!

Igor Rodionov (IR): Thank you so much for having me on. Its great to be on your podcast and hello to your listeners.

NV: Igor, what would you say is the information that gets the most attention from investors – rightly or wrongly?

IR: In our experience a large part of a factsheet is dedicated to showing performance and the reason for is that despite all the warnings and disclaimers, is that investors still use past returns to make investment decisions. We all seen the disclaimer, past performance is not a guide to future performance, however a lot of investment decisions still get maid when we compare those numbers across different products. And that’s a mistake investors make. You actually need to give those numbers a lot of context to use them effectively. You need to understand what are the objectives of the product and what it is trying to achieve. There might be many reasons for the relative outperformance or underperformance of different products. So you really need to go a bit deeper into the factsheet to get the relevant information to assist you in making an investment decision.

NV: So if I’m not allowed to use past performance as a basis for choosing investments, ETFs or other investments, what should I be looking at first?

IR: So factsheets can typically be divided into the quantitative sections, which are the numbers, returns, holdings, asset allocation percentages and the qualitative sections, which are the word sections, so they can be product descriptions, different characteristics of the product and of course for the ETFs, one of the most important bits of information is the index that it tracks. This information can be located in different parts, but the usual places is the product description section, the summary table or it could be in the title. The index is important because it will give you an idea of what exposures or risks your ETF will have. Another important section which I usually pay close attention is the product description. There you can find out specific properties of the ETF and this is usually where the product providers explain their rationale for launching this product or reasons why investors may be interested in investing in it. Information about the ETFs, may also be included there, for example if the ETF is a total return ETF, or if it’s a price ETF and whether the dividends get paid out or get reinvested.

NV: But the index is really just a recipe – it tells you what ingredients and quantities you need to bake the perfect cake (in a manner of speaking). So where do I find out what sits inside the index (and therefore the ETF), and how much of it? I mean, if I’m a diabetic, I need to check if the recipe has sugar in it or not, or if I have a nut allergy, I better make sure that the carrot cake I’m after is free of pecan nuts.

IR: Exactly. In the ETF space, it is really important to understand the index which the ETF tracks. So lets start with the basics. An index is a method to track the performance of a group of assets in a standardized way or a rule based way. Indexes typically measure the performance of a basket of securities intended to replicate certain parts of the markets. They can be quiet general for example an ETF which tracks the JSE All Share or they can be quiet niche for example a Dividend Index. There are ETFs which track multi-asset indices and there are ETFs which track specific part of the Equity market.

IR: Typically to construct each index, you need to understand what kind of securities the index can consider. This is a called the initial universe. Lets say that the initial universe for our index will be the shares listed on the JSE. Then the index can have a screening process which is just a rule which helps the index target specific securities. Lets say that we want to target the companies which pay the highest dividends. So our selecting process can be selecting shares with a highest dividend yield. Now that we have our underlying securities, we need to determine how much of we must invest into one. This is called the weighting methodology which is just a pre-determined formula. An an example can be market weighted or even equal weighted.

IR: As you can see the index is just a set of rules which determine what goes into an index.

NV: What of this information can I expect to get from the ETF factsheet, and what will I need to try and find somewhere else? And where else should I look?

IR: The factsheet will usually describe the underlying index it tracks. Another important bit of information is the Index Provider or the Index Calculation Agent. This is a company which specialises in constructing and tracking indices. Using those two bits of information you can go further and look for the Index factsheet which are usually available on the Index Provider website to learn more about the index. Now you can have a full picture of the underlying Index and understand all those things we discussed about the index.

NV: Some factsheets would also show some aggregate information on the underlying holdings, such as sector or country exposure, or perhaps the Top 10 holdings. What are some of the typical things you can expect to find, and is this important?

IR: Yes, this information can typically be found in charts or tables. This information can give you an idea of how much exposure you are getting to a specific sector or country. And of course you can also use it to see that you are satisfied with such exposure. I also like to use this information to confirm my understanding of the ETF, so if its an ETF which tracks a property index, I expect to see some Property stocks in the top 10 holdings table.

NV: By now I should have a good understanding of the all the important and relevant information relating to the underlying investments in the ETF. But what about the actual fund underneath the ETF in which the assets are held? Is this important to know and understand?

IR: Yes, most definitely. Most ETFs in South Africa are Collective Investment Schemes which means they are regulated by a specific piece of legislation and registered with the FSCA. A collective investment scheme ETF has exactly the same underlying structure as a unit trust and falls under the same regulatory framework and compliance structure as any unit trust. Here the important feature is that investors are the actual owners of the underlying investments.

IR: ETFs can also be housed in SPVs which are Special Purpose Vehicles. Essentially they are companies created with one purpose and that is to enable investors to invest in the underlying instruments. However, the difference is that the holders do not give ownership or title to the underlying instruments. However its important to note that in both cases the investor is protected by various pieces of legislation.

IR: Of course there are also ETFs which are feeder funds. Feeder funds typically invest into a fund overseas are used to allow South African investors to invest overseas without using their personal offshore allowance and use the management companies allowance instead.

IR: There are ETNs which are Exchange Traded Notes, they are not regulated by the Collective Investment Scheme Act and their purpose is to deliver an exact return the asset being tracked. However the provider is no required to physically hold the underling assets and hence it is important for investor to understand the creditworthiness of the provider.

NV: We are definitely into higher grade maths territory here, but what you are saying is that the structure or fund in which your investments are held, may be as important as what those investments are?

IR: Absolutely. If you take crypto-currency as an example. Its really important to understand where the crypto-assets are stored and who is responsible for their safety. Are they audited by a respectable party. You wouldn’t necessary trust your niece or nephew you to start investing huge sums of money into crypto-assets and it’s the same idea with the ETFs and their underlying structure.

NV: Let’s bring the conversation back to earth, and to some of the other information investors should look for on a fact sheet. Costs are always important – what should you expect to see on the fact sheet?

IR: Costs are becoming increasingly important to investors and they are probably driving the passive investment approach in South Africa and worldwide. ETF providers are obliged to show the costs which are incurred inside the ETF. The Total Expense Ratio captures the fees that incurred by the provider to manage and operate the ETF. The costs captured in the TER are annual service fees, bank charges, audit fees, custodian, trustees fees and performance fees. The transaction costs are incurred by the ETF when the underlying components needs to be rebalanced and the buying and selling occurs. The transaction costs can include VAT, brokerage, securities transfer tax, investor protection lexy, etc. If you add the Total Expense Ratio and the Transaction Costs, we will get the the Total investment Cost which is also shown on the factsheets.

IR: However some costs are not shown on the factsheet. Lets call these external costs. For example if you are buying ETFs through a platform, you have to consider those costs separately and understand how they charged. Are they once off when you buy/sell the ETF or are you paying an annual costs.

NV: What about distributions, dividends or interest. What should you be on the lookout for on the factsheet?

IR: It is important to understand whether the ETF you purchased pays the dividends out to you or do they get reinvested. This is typically shown in the factsheet, although sometimes one has to look quiet carefully. Other information which is shown is the actual distributions which get paid and its expected frequency. When our company assists in creating factsheets, we also like to calculate the dividend yield which is just a ratio of the annual dividends received compared to the current NAV. This way investors can see what proportion of their return is attributed to dividends.

NV: Another metric that is often shown on factsheets, is risk, and this can range from the simple categories like low, medium or high, to complicated statistical metrics such as standard deviation, volatility, drawdown risk, etc. What should ETF investors make of this?

IR: What we find is that most ETF providers have their own methodology on what they classify as Low Risk or Medium Risk or High Risk. Unfortunately, there isn’t an agreed standard which every provider uses. So those risk classifications can be useful across one provider, but not necessarily consistent across multiple providers.

IR: Investor’s can look at volatility (or standard deviation) of the past returns to get an idea of how they can expect their investment to fluctuate. The bigger the number, the bigger the fluctuations. This is typically shown as risk or volatility or standard deviation and can be found in a risk table. However I think a better approach is to understand what underlying asset class you are investing in, how the underlying index is constructed and whether it is well diversified.

NV: What have we missed? Is there anything else that an investor should look for in an ETF factsheet to help them decide if this is the right investment to match their objective?

IR: In some cases, the ETF factsheet may contain return numbers for the underlying ETF as well as the underling Index and show the difference in returns. One can have a look at the difference column to see if there has been any major difference, and this can be used as a measure of how well the provider is tracking the underlying index.

NV: Perhaps just as important – what is NOT important? Other than absolute past performance, what else is stuff they can ignore?

IR: Information on who are the fund managers, who are the trustees, the listing date and fund size is also shown on the ETF factsheets. Although all vaguely interesting. Its probably not that important when making investment decisions.

NV: In closing, what other tips can you share with ETF investors in reading factsheets, and doing research for their ETF investment portfolios?

IR: I think the key here is to do the research. Not to be shy to contact the ETF providers with questions as their contact information is also published on these documents and keep learning about the investment world.

NV: That concludes this episode of The ETF Investor, brought to you by the ETF Specialists, etfSA.co.za. Send us your questions and comments, or tweet us @etfSA, using the hashtag #ETFinvestor. I’m Nerina Visser for The ETF Investor – bringing Efficiency, Transparency and Flexibility to your investments.