The SPDR Straits Times Index ETF (SGX: ES3) and the Nikko AM Singapore STI ETF (SGX: G3B) track Singapore’s stock market benchmark, the Straits Times Index (SGX: ^STI). While it is simple to understand the basic function of the ETFs – they are designed to mimic the STI – the fact that there are two of them might confuse some investors. A Foolish reader recently sent us questions related to the differences between the ETFs. We thought it would be great to answer in an article. Question 1: Does the SPDR STI ETF and the Nikko AM Singapore STI ETF have…
The SPDR Straits Times Index ETF (SGX: ES3) and the Nikko AM Singapore STI ETF (SGX: G3B) track Singapore’s stock market benchmark, the Straits Times Index (SGX: ^STI). While it is simple to understand the basic function of the ETFs – they are designed to mimic the STI – the fact that there are two of them might confuse some investors.
A Foolish reader recently sent us questions related to the differences between the ETFs. We thought it would be great to answer in an article.
Question 1: Does the SPDR STI ETF and the Nikko AM Singapore STI ETF have actual component stocks in their portfolio or do they hold a mix of synthetics, derivatives and actual component stocks?
For the sake of completeness, let me first address the difference between a cash-based ETF and a synthetic ETF.
The former holds the actual shares of the constituents of the index it is tracking. The latter, on the other hand, does not hold the actual shares, but uses swaps or derivatives to mimic the index’s movement, thereby exposing itself to counterparty risks.
The Nikko AM Singapore STI ETF used to allow itself to invest in financial derivatives in order to track the STI’s performance as closely as possible.
It changed its investment focus back in end-April 2013, so that it “will not use or invest in financial derivative instruments” any longer in its aim to mimic the STI’s returns. In other words, it is now a proper cash-based ETF, holding the STI’s 30 constituents in the appropriate proportions.
The SPDR STI ETF, on the other hand, is a little trickier. This is what is written in its prospectus (emphasis mine):
“The Fund’s investment objective is to replicate as closely as possible, before expenses, the performance of the [STI]… [It] will seek to achieve this objective by investing all, or substantially all, of its assets in Index Shares in substantially the same weightings as reflected in the [STI].
Within the limits set out in the CPF Investment Guidelines and Code Investment Guidelines, [it] may invest in futures and derivatives instruments traded on Recognised Stock Exchanges and OTC Markets provided that such instruments are Authorised Investments.”
This is what the CPF Investment Guidelines has to say about the use of financial derivatives:
“Financial derivatives are only allowed for hedging and efficient portfolio management… Use of financial derivatives to replicate index performance (i.e. including but not limited to synthetic replication) is not allowed.”
Putting two and two together, the SPDR STI ETF is likely to have most (if not all) of its investable assets in the actual shares of the STI’s constituents in its quest to track the index.
This is further backed up by the Singapore Stock Exchange, which lists the SPDR STI ETF (as well as the Nikko AM Singapore STI ETF) as cash-based ETFs.
Question 2: What are the salient differences between the 2 ETFs?
When choosing ETFs, especially ones that track the same underlying index, there are two important considerations. The first would be total expenses. If left unchecked, expenses can often eat into investors’ returns.
The next consideration would be an ETF’s tracking error. It tells us how much an ETF would deviate from the index’s performance. If the tracking error is large, then significant portions of an index’s gains might be lost by the ETF.
Let’s see how both the STI ETFs compare on both fronts:
|ETF||Total Expense Ratio||Annualised Tracking Error|
|SPDR STI ETF||0.3%||0.66%|
|Nikko AM Singapore STI ETF||0.28%||1.06%|
|*Data as of 31 Aug 2013|
We can see that the ETFs differ only slightly in terms of total expenses, while having a more pronounced difference in tracking error.
Question 3: Which in your view would mirror more closely the STI and be more “robust” when there is market volatility?
Based on the historical tracking-error figures above for both ETFs, the SPDR STI ETF has been the one that’s able to track the STI more closely.
It should be noted though, that the SPDR STI ETF has been in existence since April 2002, while the Nikko AM Singapore STI ETF’s only been around since Feb 2009. So, there’s a much longer time for the former to fine tune its operations and execution compared to the latter.
Perhaps, Nikko AM’s tracking error might slowly narrow in the future? That’s an answer we can’t really know ahead of time.
In any case, both ETFs have relatively low absolute tracking errors, so they are both likely to be “robust” in mimicking the Straits Times Index.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing doesn’t own shares in any companies mentioned.