What the ETF?

Understanding the technicalities of Exchange Traded Funds (ETFs)

By Muhammad Raafay Khan

You have probably heard of mutual funds, which is a place to put your money if you want to forget about it for a while. But now there is a hot new fund in town called an Exchange Traded

Fund (ETF).

An ETF is a type of fund which trades like a stock on the Pakistan Stock Exchange (PSX), has lower management fee than mutual funds, and tracks specific indices such as the KSE100. Globally, ETFs are worth $ 10 trillion. In Pakistan, however, the ETF market is still in its nascent stages with just below $ 4 million (Rs 850 million) of assets under management (AUM).

Today we try to understand these ETFs, what kind of ETFs are available on the PSX, and we look at one ETF in particular, the National Bank of Pakistan Growth ETF (NBPGETF).

What are ETFs?

An ETF is an investment product offered by Asset Management Companies (AMC). They consist of a basket of securities that tracks an index (aka Benchmark Index). ETFs are available to investors on the stock exchange and trade like stocks with real time pricing during trading hours. The aim of the ETF is to mirror the performance of the index it tracks.

Naturally, the performance of an ETF is dependent on the performance of the underlying securities it holds, much like a portfolio of stocks held by an individual investor. Like all financial products, ETFs have a risk. However, they may face a lower specific risk than a particular stock as they comprise a basket of stocks. They diversify your investment if you can’t diversify them yourself.

Like stocks, ETFs have two types of returns: a) Capital Gains: Investors can trade

ETFs like a stock by buying it at a low price and selling it at a high price to realise the profit/gain. b) Dividends: The ETF fund manager earns dividends from the securities that comprise the ETF basket, which may be distributed to ETF unit holders after the deduction of management fees etc. The dividend distribution policy of ETFs are described in their prospectus or offering document. Dividends received by ETFs are tax exempted (for the fund, not the investor) provided 90% of dividend income is distributed to unit holders.

Individual stocks and ETFs trade alongside each other on the stock exchange but there are two major differences. First, ETFs are generally much more diversified as they comprise a basket of stocks. Second, most ETFs track specific indices, whereas individual stocks do not (obviously).

Investing in ETFs is generally better from a diversification perspective which begs the question, why not just diversify in stocks yourself?

Well, the main reason ETFs are preffered is that investing in ETFs saves the individual investor the time and hassle required to research and make stock-specific investment decisions themselves. The costs/fees of investing in ETF units are also generally lower compared to mutual funds. However, new investors should understand the risks associated with investing in equity markets. ETFs are traded in the PSX and no front and often no back-end fee is charged. The front-end fee is the fee charged by mutual funds at the start when you invest in them. The back-end fee is charged when you take your money out from a fund. However, ETFs do charge a management fee which is determined by a lot more factors than what the ETFs brochures simply put under “management fee”.

The trading price of an ETF is determined by the demand and supply of the ETF unit in the market. Like mutual funds, ETFs have a Net Asset Value (NAV) (total assets minus total liabilities) which is published daily after close of the stock market for investors to actually gauge the underlying value of their holdings.

In addition, investors also have the benefit of an Indicative NAV (INAV) available at specified frequency during the trading hours to help them make trading decisions. ETFs are designed in such a way that they trade at a price close to their underlying basket price. Investors are informed of the INAV of the ETF units/shares which is disseminated at specified intervals of time throughout trading hours.

Even though the difference between the NAV (share price) and INAV (actual value of fund assets) is often small, market forces often lead to times where the ETF will trade at a discount or premium to its INAV.

On the other hand, a mutual fund isn’t priced until the trading day is over. And mutual fund units are purchased directly from the mutual fund at the respective NAV. Investment in mutual funds may be subject to front-end or back-end load/sales charges, whereas investors in ETFs are subject to brokerage charges and management fees.

Types of ETFs available on the PSX

There are seven ETFs currently available on the PSX, and all of them track a different index. ETFs in Pakistan are in their nascent stages. The first two ETFs were launched in March of 2020 followed by two others in the same year. And then three more ETFs were launched in 2022 making a total of seven ETFs currently. Take a look at the diagram for a brief overview of the different types of ETFs available on the PSX. 1. NIT Pakistan Gateway ETF (NITGETF) was one of the first two ETFs launched on March 24, 2020. It aims to track the NIT Pakistan Gateway Index that represents the top 50% free-float market capitalisation of KSE-100 at all times. 2. UBL Pakistan Enterprise ETF (UBLPETF) is the other first-launched ETF which aims to track the performance of top nine companies with highest free-float market capitalisation of KSE-100 index (excluding Oil and Gas sector companies). 3. Meezan Pakistan ETF (MZNPETF) is the only Shariah compliant ETF on the PSX which aims to track the Meezan Pakistan Index (MZNPI). The Islamic Index aims to track the performance of top 12 companies with highest average traded value and free-float market capitalisation of KMI30 Index, which only includes 30 shariah compliant stocks.

4. NBP Pakistan Growth Exchange Traded Fund (NBPGETF) aims to track the NBP Pakistan Growth Index (NBPPGI), which is constituted by selecting the top companies of the KSE-100 index based on market capitalisation, liquidity and volume. NBPGETF invests in a diversified portfolio of 15 blue-chip companies across seven sectors. We will explore this ETF in detail in the next section. 5. The JS Momentum Factor ETF (JSMFETF) aims to track the JSMFI index. The JSMFI tracks the performance of stocks which define positive momentum based upon total return performance and value traded over a 30-day time period. 6. Alfalah Consumer Index Exchange Traded Fund (ACIETF) tracks the Alfalah Consumer Index (ACI) which comprises a maximum of 20 consumer focused stocks. 7. HBL Total Treasury Exchange Traded Fund (HBLTETF) is the only debt ETF which aims to track the performance of HBL Total Treasury Index (HBLTTI). This benchmark index is a blend of short- and medium-term government securities issued and/or guaranteed by the government of Pakistan. Among ETFs, it has the largest fund size of Rs 524 million. Because it is the only government debt ETF, it has the lowest risk of all the ETFs.

National Bank of Pakistan Growth Exchange Traded Fund (NBPGETF)

The NBPETF is managed by NBP Fund Management Limited (NBP Funds) a leading Asset Management Company (AMC) of Pakistan. As of January 12, 2023, the market cap of the ETF is Rs 52,458,000 with a NAV of Rs 9.66. The fund has total AUM of above Rs 53 million. The NAV of the fund is calculated by dividing the value of the net assets of the fund (i.e., the value of its total assets less total liabilities) by the total number of outstanding shares of the fund. The NAV is the stock price of the ETF on the PSX. To check the stock price performance of the fund, take a look at the historical NAV since May of 2022 in the graph.

NBPGETF December 2022 performance:

According to the fund manager report for the month of December 2022, the fund posted a negative 5.5% return against a negative 5.4% return of NBP index. The rolling 12 months return of the fund was negative 13.5% against the benchmark return of negative 12.5%. And since the launch of the fund on October 06, 2020, the fund has given a positive 0.5% return against the benchmark index return of 2.9%. The NAV was Rs 9.4381 at the end of December.

Looking at the portfolio of the NBP ETF, we can see that it has diversified its investment in 10 blue chip stocks. Blue chip stocks are stocks of well-reputed companies which are popular among investors. Stocks such as ENGRO, OGDC, UBL, and so on are some of the best managed companies in the PSX. The diversification of stocks is certainly remarkable for the NBP ETF. For stock market investors who don’t like investing in funds, ETFs still have something to offer you. It might not be the worst idea to take cues and try to replicate the basket of stocks of a particular ETF to make your own portfolio of stocks. You’ll have a nice diversified portfolio and what’s even better is that you can avoid the management fee!

To summarise: • ETFs can offer lower operating costs than traditional mutual funds, flexible trading, and greater transparency by disclosing all holdings etc • An ETF is one way to invest in the stock market without buying individual stocks • By investing in an ETF, your money is instantly diversified across all of the underlying securities in the basket • ETFs provide an easy way to diversify across different stocks, commodities, bonds, or other securities in the markets where many

ETFs across multiple asset classes exist We hope this guide to ETFs was helpful. n Disclaimer: This article is not meant as an investment advice. Info source: Pakistan Stock Exchange (PSX)