By JOANNE GOH

INVESTORS, big or small, are now a step closer to seizing investment opportunities offered by the global markets while trading within the convenient, efficient and regulated environment of SGX. The exchange now quotes 40 exchange-traded funds (ETFs) offering investors efficient access to a wide spectrum of major world indices with different risk profiles and direct exposure to developed markets as well as specific emerging market regions.

We believe liquidity will grow as investors become more familiar with ETF investing in Asia. In the US, there are already close to 1,700 ETFs listed providing access to US and other major markets as well as sectors and specialty ETFs.

Benefits

ETF is an exchange listed fund which consists of a basket of stocks. It hence provides investors with diversification as opposed to buying an individual stock listed on the exchange. ETF typically tracks an underlying benchmark index or a basket of stocks where the list of stocks and their weightings in the fund are known. Typically, the sponsor of ETF does not actively manage the list of stocks, like a mutual fund or unit trust manager does, but instead tries to track the ETF as closely to the benchmark index as possible. Diversification, transparency and the low management fees are the three main benefits of buying into an ETF.

Risks

Investors should know that, just like buying into any stock, they are exposed to market price fluctuations when buying into ETF. As the underlying stocks may be in another market outside Singapore or quoted in a non-home currency, investors are also exposed to currency risk. A sponsor of the fund typically hedges its position by buying into the underlying stocks in the index. Counter-party risks exist when the underlying index is backed by swaps to minimise tracking errors or the underlying stocks may be lent out to reduce transaction costs.

ETF users

The first real interest in ETF investing in the US started during the tech boom - any retail investor then who wanted to partake in the tech boom would buy into QQQ, an ETF which tracks the Nasdaq index. With a broad range of ETFs being created, hedge funds and portfolio managers actively use ETFs as an efficient way of portfolio construction and implementation.

For example, an Asian fund manager may build a portfolio consisting of APEX SP (ETF consisting of top 50 stocks in Asia ex-Japan) plus some other alpha picks. A macro hedge fund manager may engage in pair trade, which is long one ETF and short one ETF. Recently POSB and DBSAM jointly launched a unit trust through the use of ETFs listed on SGX across two asset classes: DBS Singapore STI ETF (DBSSTI SP Equity) and ABF Singapore Bond Index Fund (SBIF SP Equity). Three separate sub-categories are created with different combinations of equities and bond portions.

Private bankers also recommend ETFs as a way to get access to difficult markets and asset classes, for example, in India and China where there are restrictions to foreign investors. Retail investors are now able to conveniently access ETFs which are listed on their local exchange with small board lots, or could be used even as a monthly savings plan buying into these ETFs.

Time is right

The current positive equities climate provides an opportune time for investors to re-look at the merits of ETF investing, especially in equities ETF. We are positive on equities as an asset class as we believe we are at the bottom of economic, interest rate, asset and valuation cycles. Global equity indices have staged a heady recovery over the past few months, especially in the emerging markets. We believe the re-rating in world equities has only just started and there is still quite a way to go for the full extent of the expected recovery to be priced in. Typically stock markets recover in line with economic recovery. Resetting to the bottom of the cycle means a better return/risk profile going forward.

We believe the global GDP data will improve sequentially, beginning with Asia which bottomed out in Q1, US in Q2, and subsequently Japan in Q3 and Europe in Q4. The likelihood for data to disappoint is low in our view and recovery may come earlier than expected given the recent positive economic momentum. Meanwhile, world valuations are still at very low levels, which mean there is still room for P/E expansion. The potential for global markets to re-rate in line with a sharp recovery in GDP growth over the next 6-12 months should keep the global equities market uptrend intact.

Direct Singapore exposure ETF (STTF SP, DBSSTI SP)

In recent years, Singapore's forward PE has de-rated severely against the Asian region - largely as a result of fund flows favouring emerging markets in the region over developed markets. Being heavily dependent on external economics, Singapore was among the first countries to be severely affected by the current downturn and its PE premium to the region is towards the lower end. However, the de-rating is also very much evident compared to its closest developed market peer in the region with similar dynamics - Hong Kong.

As we get near to the start of a cyclical upswing, we believe this trend is no longer sustainable and a re-rating of the P/E premium closer to the historical mean is on the cards. A look at Singapore's historical market P/E relative to GDP growth clearly establishes a strong case for Singapore's current valuations to re-rate on the back of positive GDP growth figures expected over the next two to three quarters.

Other potential re-rating drivers for Singapore are:

• We are looking for positive momentum in sequential growth for the next few quarters. The stability of the financial markets could also bring about an earlier than expected recovery of business and consumer sentiment, thereby exerting a multiplier effect on the economy. Early cyclical sectors should be the first beneficiaries in a cyclical upturn. We also look for sectors with potential earnings upgrades that could come from (i) worst-case expectations having been built in, for example, Singapore banks; (ii) higher oil prices, such as off-shore marine, plantation and energy sectors; (iii) credit easing for example, Reits, off-shore marine sector, and (iv) a pick-up in residential property sales momentum benefiting the property sector.
• Reflationary expectations. The Singapore economy remains in a deflationary mode for now but not for long. We expect Singapore inflation to revert to positive levels by February next year. Given the sharp fall in commodity and housing prices since July last year, a very low interest rate environment, and massive rescue efforts by central banks and governments, bets that the world economy will rebound should bring about reflationary expectation next year. Early reflationary trades are banks, property and commodities.
• Effective economic management in Singapore (vs rest of developed markets). Flexible government policies and confidence in policy-makers to respond and tackle both demand downturns as well as potential overheating, will help sustain the recovery in Singapore.
• Exposure to emerging markets growth in its sectors. In sectors such as palm oil, offshore and marine, Singapore is poised to benefit from renewed growth in regional emerging economies.
• Integrated Resorts. This is the proverbial wild card in the equation. According to DBS Vickers' recently released thematic report on 'Integrated Resorts Spin Offs', the IRs are estimated to add 1.5 per cent to Singapore's GDP, creating 60,000 direct and spin-off jobs in the process. The ripple effect from these two iconic developments is expected to be far-reaching, ranging from gaming, hospitality, and property to service providers such as retail, media and transport operators.

China exposure

We also believe investors should get exposure to China's story. It has the world's highest GDP growth and largest population, potentially a key demand driver for global growth. Under the weak global economic backdrop, what sets China apart from other countries is its strong fiscal muscle and the abundant liquidity. Looking beyond the numerical significance of China targeting 8 per cent growth, the more important message is that the central government will do all it can to prevent a sharp downturn. Recent correction caused by concerns of credit tightening presents a good opportunity to buy into the market. Growth in the Chinese economy is still on track, and our economist believes there is no justification for a U-turn in monetary policy in view of the still weak external environment. Moreover credit growth has started to decelerate, reflecting the effectiveness of the verbal intervention. Our China banking analyst believes that a slower loan growth in the second half is consistent with banks' practices in the past years. We expect domestic liquidity in China to remain abundant.

Investors can get access to the China market via a few available funds:

• FTSE/Xinhua China 25 ETF (XX25 SP) has the largest 25 Chinese listed companies in Hong Kong, including industry giants China Mobile, CNOOC, ICBC, China Life Insurance, Petrochina, each capped at maximum of 10 per cent weight in the index. We believe this is the best way to capture China's growth. Some of these Chinese companies, like China Mobile, may not necessarily be listed in China.
• China Enterprise ETF (ASI SP) captures the H-shares which are listed in Hong Kong. It is a good proxy for the China A share market in terms of stock representation, but at lower valuations than A shares.
• Hang Seng Index ETF (HSI SP) consists of large Hong Kong listed stocks, with a combination of HSBC, China focused and Hong Kong focused stocks. We estimate about 52 per cent of HSI market cap are China-themed stocks.

Joanne Goh is regional equity strategist and head of ETF research at DBS Bank

This article was first published in The Business Times.