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Learn about the benefits, fees, and risks of Exchange Traded Funds (ETFs) and how to implement passive investing strategies using Dollar-Cost-Averaging and Asset Allocation. Real-life examples and backtesting results included.
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Passive long term investing strategies with ETFs Emanuel Oswald CERN Finance Club 5th March 2019
Content • What is an ETF • Types of ETFs • Fees and Risks of ETFs • What is passive investing • Dollar-Cost-Averaging • Asset Allocation and Reallocation • Examples from Backtesting finance.yahoo.com
What is an ETF? • ETF (Exchange Traded Fund)Tracks an Index (“basket of stocks”) • e.g. S&P 500, STOXX Europe 600 finance.yahoo.com
What is an ETF? • ETF (Exchange Traded Fund)Tracks an Index (“basket of stocks”) • e.g. S&P 500, STOXX Europe 600 finance.yahoo.com
Types of ETFs • Two replication methods • Physical replication • ETF “buys” stocks which represent the index
Types of ETFs • Two replication methods • Physical replication • ETF “buys” stocks which represent the index • Synthetic replication (SWAP ETF) • ETF consists of securities different from stocks in the indexcompensation of difference in performance with SWAP partner • Tax advantages, cost advantages
Types of ETFs • Two replication methods • Physical replication • ETF “buys” stocks which represent the index • Synthetic replication (SWAP ETF) • ETF consists of securities different from stocks in the indexcompensation of difference in performance with SWAP partner • Dividend paying ETF • Dividend is paid to owner of ETF on regular basis (monthly, quarterly, yearly) • Accumulating ETF (Dividends automatically reinvested) • Dividend is automatically reinvested • Reflected in increased ETF price
Fees and Risks of ETFs • Total Expense Ratio (TER) (SPY ETF: 0.09% p.a.) • Management fees, other costs • Trading costs are not included
Fees and Risks of ETFs • Total Expense Ratio (TER) (SPY ETF: 0.09% p.a.) • Management fees, other costs • Trading costs are not included • Tracking Difference • Shows the difference in the capital appreciation of the index and ETF
Fees and Risks of ETFs • Total Expense Ratio (TER) (SPY ETF: 0.09% p.a.) • Management fees, other costs • Trading costs are not included • Tracking Difference • Shows the difference in the capital appreciation of the index and ETF • Counterparty risk • SWAP ETF: SWAP partner is insolvent and cannot pay • Limited to max 10% of ETF value (UCITS regulations) • In reality much smaller (securities of SWAP partner) • Physical ETF: securities lending • ETF lends stocks to others (typically short sellers) • ETF improves performance due to lending fee (positive tracking difference possible!)
Fees and Risks of ETFs • Total Expense Ratio (TER) (SPY ETF: 0.09% p.a.) • Management fees, other costs • Trading costs are not included • Tracking Difference • Shows the difference in the capital appreciation of the index and ETF • Counterparty risk • SWAP ETF: SWAP partner is insolvent and cannot pay • Limited to max 10% of ETF value (UCITS regulations) • In reality much smaller (securities of SWAP partner) • Physical ETF: securities lending • ETF lends stocks to others (typically short sellers) • ETF improves performance due to lending fee (positive tracking difference possible!)
What is passive investing? • Active investing • Goal is to “beat” the market • Stock picking • Market timing • Passive investing • Goal is to make the market performance • No single stock risk (broad diversification) • Investing with fixed rules (elimination of emotions) • Periodical investments (monthly) • Asset allocation (ETF USA, ETF Europe, ETF EM, US Treasuries, REITs, Apartement, Gold, Cash, …) • Asset reallocation
Passive investing strategy • Dollar-Cost-Averaging • Periodically buying the index (ETF) (e.g. monthly, quarterly) • Same amount of money every month is invested (e.g. $100,- per month)
Passive investing strategy • Dollar-Cost-Averaging • Periodically buying the index (ETF) (e.g. monthly, quarterly) • Same amount of money every month is invested (e.g. $100,- per month)
Passive investing strategy • Dollar-Cost-Averaging • Periodically buying the index (ETF) (e.g. monthly, quarterly) • Same amount of money every month is invested (e.g. $100,- per month)
Passive investing strategy • Dollar-Cost-Averaging • Periodically buying the index (ETF) (e.g. monthly, quarterly) • Same amount of money every month is invested (e.g. $100,- per month)
Example • Monthly investment of $100,- for ~26 years in S&P 500 ETF • Dividends reinvested (price data is recalculated) • Money invested $31,300 • Money in the end $108,259 • Internal rate of return 8.5%
Example • Monthly investment of $100,- for ~26 years in S&P 500 ETF • Dividends reinvested (price data is recalculated) • Money invested $31,300 • Money in the end $108,259 • Internal rate of return 8.5%
Example 6.6% p.a.
Example 6.6% p.a. 1.1% p.a.
Example 11.0% p.a. 6.6% p.a. 1.1% p.a.
Example 11.0% p.a. 6.6% p.a. 1.1% p.a.
Passive investing strategy • Asset Allocation and Reallocation • Two or more ETFs • ETF S&P 500: 60% • ETF 20+ year Treasury Bond: 40%
Passive investing strategy • Asset Allocation and Reallocation • S&P 500 performs different than Treasury ETF • Asset Reallocation at fixed date or at fixed aberrationof start allocation • Fixed date: After one year asset allocation: 67% : 33% (60% : 40%) • Sell some parts of S&P 500 and buy some parts of Treasury ETFso that 60% : 40% asset allocation is reset • Fixed aberration:Rule: When start allocation is 5% off reallocate • After some months asset allocation: 62.5% : 37.5%
Treasury ETF is anti correlated in Recession compensates for losses in stock market This typically happens because interest rates are lowered in recessions bonds raise in price
50% : 50% asset allocation with asset reallocation every 6 month improves IRR to 4.8%
