Essay: Understanding ETFs - Evolution, Asset Classes, And Major ETFs In USA And Australia.

1. Discuss your understanding of Exchange Traded Funds (ETF). Your discussion will cover the evolution of global ETF structure; ETFs categorized on the basis of asset classes:Equity, Fixed Income and Commodity: major ETFs in USA and Australia.

Overview of Exchange Traded Funds (ETFs)

Vanguard MSCI Australian small companies index is an exchange traded fund that intends to match the return in terms of capital appreciation and income of the MSCI small cap index Australian shares. The fund is a small capitalisation index that generally involves smaller companies on the equity market of Australia that target coverage of around 14% of free float of market capitalisation of share market that is adjusted. Such return from fund is considered before the expenses, tax and fees are taken into consideration. The fund intends to provide investors with diversified exposure and low cost to the small companies that is listed on stock exchange of Australia. This is indicative of the fact that investors are provided with the low cost way for making investment in the portfolio of smallest companies of Australia. A sector in which the investment is made by the fund involves materials, industrial, financials, real estate, information technology, healthcare, Utilities, energy, consumer staples and customer discretionary (Stettina and Hörz 2015). It can therefore be seen that the fund makes investment in diversified sectors with maximum percentage of allocation made in materials sector and minimum allocation made in 1.2. A long term potential capital growth is offered by the fund that can be typical to the market sector of small company.

The objective of fund is to track the appreciation of capita and income of the FTSE ASFA Australia index high dividend yield. Most of the securities of fund will involve FTSE ASFA Australia index high dividend yield that will allow weighting on individual security to vary marginally from index. In addition to this, investment in securities may be made by fund that is expected to be included in the index it has been removed form index. The fund provides investors with benefits of diversification, potential return that is tax effective, risks and potential of capital growth and income that is tax effective. Moreover, fund has potential for some loss of capital and generating returns that is below average with higher risk level. Investors are able to achieve broad range of diversification across multiple classes of assets with exchange funds of lower class. A label fixed interest strategy is offered by fund that helps in preservation of risk characteristics and diversification of varied range of assets by making investment in securities of higher grade (Klingebiel and Rammer 2014).

The above graph depicts that the performance of fund has improved over the years. The closing price of fund as on 5^th May, 2018 stood at AUD 57.34 and has a share class size of 153.28.

Evolution of Global ETF Structure

The above table depicts the performance of fund ranging from time period of 1 month to 10 years. Growth of fund during the time period of one month was negative at -1.97 while that of five years growth stood at 3.09. Highest growth was recorded during six months and one year. Portfolio of assets incorporated into this particular fund comprises of top ten holdings namely Iluka resources Ltd, Star entertainment group limited, Spark Infrastructure group, Northern star resources limited, Evolution mining limited, ALS limited, Ansell Limited, Downer EDI Limited and Link Administration holding limited (DeFusco et al. 2015).

The above chart represents the payment of dividend to investors by vanguard fund. From above chart, it can be seen that total amount of annual dividend paid to investors was highest in year 2017 at $ 2.17, whereas total amount of franked dividend was highest in year 2016 at $ 0.97. Year 2018 witnessed lowest amount of dividend both in terms of franked dividend and total dividend at $ 0.57 and $ 0.44. 

The performance of portfolio of stocks is analyzed using the Sharpe and Teynor ratio.

It can be seen from the table that the portfolio of assets have negative Sharpe ratio at -2.85 that is indicative of the fact that portfolio is generating negative return. Negative value depicts that investors that there is higher volatility in the market but return is negative. Treynor ratio is also negative at value -0.03. This negative value depicts that portfolio of stocks has not generated risk adjusted return. The beta value of portfolio stood at 0.823 and the standard deviation stood at 0.009. Therefore, the performance of stocks is negative and investors should not make investment into such portfolio.

The efficient portfolio is constructed by using different target returns for the eleven stocks that have formed the portfolio. For target return of 1%, value of both Sharpe as well as Treynor ratio stood at negative at -0.05 and -0.01. For target return of 2%, Sharpe ratio and Treynor ratio stood at -0.012 and -0.005. For these two levels of target returns, return of the stocks of portfolio is negative depicting that making investment in portfolio of these stocks is risky.

When considering the target return of 3%, 4%, 5%, 6%, 7%, 8%, 9%, 10%, 11%, 12%, 13%, 14%, 15%, 16%, 17%, 18%, 20% and 25%, the value of Sharpe and Treynor ratio has come to positive indicating that stocks will be generating positive return and higher the value of ratios depicts that returns from the stocks will be return adjusted (Schyns 2016). It can be seen that when the percentage of target return is increasing, then the value of Sharpe as well as Treynor ratio is also increasing.

ETFs Categorized on the Basis of Asset Classes: Equity, Fixed Income and Commodity

The following table depicts the comparison between Treynor ratio and Sharpe ratio in the construction of efficient frontier for different level of target returns.

For the returns that are equally weighted, the return generated using Sharpe ratio stood at -285.53% and that of Treynor ratio stood at -3.31%. For the target level of return that is lower, it can be seen that value of both the ratio is negative indicating that returns are not adjusted for risks and stocks are generating negative return. With the increase in level of target return, the returns generated by the portfolio of stocks are increasing. Furthermore, it can also be seen that the value of Sharpe ratio for every level of target return is more than Treynor ratio. However, for the target return at 25%, it can be seen that value of Sharpe ratio is more than that of Treynor ratio. In addition to this, there is increasing deviation from average return of the portfolio of stocks when there is increase in target return. Therefore, the deviation from mean value increases when there is increase in set target value.

When looking the performance of portfolio using Sharpe ratio as performance measure, it can be seen that the return of stocks is negative at the target return of 1% and 2%. Using Teynor ratio as the performance measure, the return of stocks is negative for the target return of 1% and 2%. On other hand, for all the other target returns that have been set, the performance of portfolio is favourable as depicted from both the performance measures. 

References list:

Cornell, B., Hsu, J. and Nanigian, D., 2017. Does Past Performance Matter in Investment Manager Selection?. The Journal of Portfolio Management, 43(4), pp.33-43.

Cosio, R.M., Estrada, J. and Kritzman, M., 2015. New Frontiers in Portfolio Management.

DeFusco, R.A., McLeavey, D.W., Pinto, J.E., Anson, M.J. and Runkle, D.E., 2015. Quantitative investment analysis. John Wiley & Sons.

InvestSMART. (2018). Vanguard MSCI Australian Small Companies Index ETF. [online] Available at: https://www.investsmart.com.au/shares/asx-vso/vanguard-msci-australian-small-companies-index-etf [Accessed 10 May 2018].

Kahn, R.N. and Lemmon, M., 2016. The asset manager’s dilemma: How smart beta is disrupting the investment management industry. Financial Analysts Journal, 72(1), pp.15-20.

Kaiser, M.G., El Arbi, F. and Ahlemann, F., 2015. Successful project portfolio management beyond project selection techniques: Understanding the role of structural alignment. International Journal of Project Management, 33(1), pp.126-139.

Kevin, S., 2015. Security analysis and portfolio management. PHI Learning Pvt. Ltd..

Klingebiel, R. and Rammer, C., 2014. Resource allocation strategy for innovation portfolio management. Strategic Management Journal, 35(2), pp.246-268.

Lashley, G., Parker, G., Singh, S., Wise, J. and Polwitoon, P., 2017. Managing Your Investment Portfolio: All Things ETF.

Schyns, P.F.M., 2016. The technological future of the wealth management industry for portfolio management investment services (Bachelor's thesis, University of Twente).

Stettina, C.J. and Hörz, J., 2015. Agile portfolio management: An empirical perspective on the practice in use. International Journal of Project Management, 33(1), pp.140-152.

Vincent, K., Hsu, Y.C. and Lin, H.W., 2018. Analyzing the Performance of Multifactor Investment Strategies under a Multiple Testing Framework. The Journal of Portfolio Management, 44(4), pp.113-126.