The Use Of Exchange Traded Funds ETFs To

The Use Of Exchange Traded Funds (ETFs) To Encourage Investment And Stockmarket Development Presentation to: Africa Investment Climate Conference 5 October 2006 MIKE BROWN General Manager Satrix Managers

Agenda • What are Exchange Traded Funds (ETFs)? • What are their features and benefits? • ETFs in South Africa. • How do ETFs help in development of stockmarkets. • Possible ETF products for African stockmarkets.

Exchange Traded Funds (ETFs) An ETF is an entire index structured so it can trade like a share. “Buy one share and own the market”

What Are Exchange Traded Funds? • Portfolios which trade on stock exchanges. • About 400 Index ETFs now listed around the world – with US$360 billion under management. • Being listed means that: – ETFs can trade all day to take advantage of intra day price movements – Settlement, clearing, registration guarantee of trade, takes place through normal market mechanisms. – Price transparency, liquidity and record are ensured.

Benefits of ETFs • Low costs.

Cost Comparison Between Active and Passively Managed Funds AVERAGE EXPENSE RATIO United States AVERAGE EXPENSE RATIO Basis Points (bps) Exchange Traded Funds Europe Basis Points (bps) Exchange Traded Funds Large cap ETFs 28 European exposure 45 All equity ETFs 40 Global exposure 47 International equity ETFs 52 Mutual Funds Average equity fund 162 120 Actively managed domestic equity 115 Average index fund Actively managed international equity 189 Source: Morgan Stanley, International Equity (January 2006)

Benefits of ETFs • Low costs. • Increase liquidity.

Satrix 40 – Annual Trading Statistics

• Benefits of ETFs (continued) Provide low cost, efficient vehicle for passive (index) investment. • Over time, net of costs, 70% or more of active managers fail to outperform index tracker funds. Why? • Indices include only blue chip large market capitalisation companies that dominate trading in the markets. • Main indices usually provide all the portfolio diversification and spread required by investors. • Index trackers give perfect beta of one. • Low costs do not erode investment performance. • ETFs are typically highly tradable and offer instant liquidity through market makers.

ETFs In South Africa • Special Exchange Traded Fund sector on the JSE Main Board. • Nine ETFs currently listed on JSE. • Include: – Satrix – 5 securities (local indices) – Itrix - 2 securities (foreign indices) – Absa – Rand Gold Price index & Rand Hedge basket • Market capitalisation R 13, 2 billion • Turnover, particularly in Satrix, is very good.

Satrix Securities Listed on the JSE Product Portfolio Features Performance Return per annum 1 Year 3 Years Satrix 40 JSE Top 40 companies Diversified portfolio of the top 40 companies on the JSE. 55, 0% 39, 9% Satrix Fini JSE Top 15 companies Portfolio of major JSE banks and insurance companies. 35, 8% 36, 4% Satrix Indi JSE Top 25 companies Industrial companies are major beneficiaries of strong domestic economic growth. 33, 6% 41, 1% Satrix Resi JSE Top 20 mining Participate in the global and commodity price boom with stocks strong rand hedge qualities. n/a Satrix Swix Top 40 JSE Adjusted Top 40 index n/a A smoothed out and less volatile index of the JSE top 40 shares. Source: Unit Trust Survey (June 2006)

How ETFs Help in Stockmarket Development? • They attract the following investors: – Hedge funds who prefer to invest in an index rather than single shares. – Facilitate hedging – ETFs can be shorted like any listed share. – Arbitrage between spot and futures indices is encouraged. – Provide platform for derivative and structured products. – Appeal to country investors. Continued/…

How ETFs Help in Stockmarket Development? (continued) • They bring in retail and first time investors. –Low costs –Easy to understand –Transparent –Can be transacted through low cost platforms, such as the Satrix Investment Plan. Provide access to the equity market. Continued/…

How ETFs Help in Stockmarket Development? (continued) • ETFs add liquidity and encourage greater trading in the underlying index stocks. • The asset manager of the ETF has to buy securities in the underlying index stocks as he has to exactly replicate the index. This may enable the index companies to issue more securities and raise capital. • Create competition for companies to join the main market index.

What ETF Products Can Be Used For African Stockmarket Development? 1. • Develop ETFs for the main indices of individual African stockmarkets. Need – – – Good liquidity in the underlying index stocks Enabling legislation for effective operation of a collective investment, or discretionary trust structure. Participation of local stockbroking and investment banking community. Helps to have futures or forward OTC’s trading on the index being tracked. Active participation (or ownership) by the stockmarket on which listing takes place. Continued/…

What ETF Products Can Be Used For African Stockmarket Development? 2. Pan African Index. – 2 to 3 of the top companies from each of the main African stockmarkets • Need – Compiler of the index. – ETF can trade on each of the contributing stockmarkets and/or on separate “Pan African” platform – Settlement, transfer and registration systems need to be homogenized or integrated. – Management company. Continued/…

What ETF Products Can Be Used For African Stockmarket Development? 3. Index of African companies listed on the JSE. – – • D 441 exchange control circular allows for “inward listing” of African companies on the JSE. Also allows for increased foreign exchange allowance for SA institutions that invest in African companies. Need – – A lot more African companies to list on the JSE. Compilation of an index of such African JSE companies.