After the board of Karachi Stock Exchange approved the regulations for exchange-traded fund last week, there has been a lot of talk about the product in the corridors of our bourses. Since most of that talk revolved around what is ETF and what fruits will it bring to us?! we at BR Research thought it would be interesting to resolve that mystery.
For investors, ETF offers the best of both worlds: tradability aspect of close-end fund and dynamic capital size of the open ended ones. These features eliminate the need for conventional close ended funds by effectively reducing the NAV-to-price discount to zero, as any change in price and NAV creates a real time arbitrage opportunity. Hence, not only will they add depth and width to the stock market but also enhance efficiencies in the asset management industry.
It minimises the inefficiencies of open-ended funds, by virtue of disseminating information, in pricing governed by market mechanism. For conventional open-ended funds, the information reaches the investors, through fund managers reports, usually after a lag of about a month.
Moreover, in the interest of investors and top management, the fund performance will be a reflection of real time changes in fund size. It will be cost efficient for investors, too, as it replaces the high cost, front-end and back-end load that ranges between 1 to 5 percent, with a minimal broking fee.
ETF, like other open ended funds, can be in equity, income, hybrid and index funds, and, being a security traded on stock exchanges, will also have future contracts. An index ETF, or any other combination of portfolio, would help stock investors hedge their own portfolio by selling future contracts of a similar portfolio ETF - plugging the need for a much required portfolio-hedging instrument in the stock market.
In developed markets, an open ended fund is usually launched with its counterpart ETF. This does not only facilitate investors choice but also adds width to the stock market by increasing capitalisation; on the other hand its hedging feature enhances the stock markets depth.
ETF has witnessed remarkable success in other developing markets - such as in Turkish markets, ETF under management jumped from $3.19 million in January 2005 to $69.83 million in November 2007. And, if the authorities work things out the right way, there is no reason why a similar success story cant be seen in Pakistan.
The effort of leading market players such as JS Investment Limited and Arif Habib Investment Management, who are currently working to finalise the trust deeds of the product, is the right step in the right direction and it will hopefully lead Pakistans nascent capital market to the much-needed next phase of development.
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