Investing in Exchange Traded Funds

What Is an Exchange Traded Fund?

An exchange traded fund (ETF) is a listed investment vehicle that holds a basket of underlying assets, such as equities, bonds, commodities, or a combination, and trades on a stock exchange in the same way an ordinary share does. When you buy a unit in an ETF, you acquire proportional exposure to every asset in that basket. The price of the ETF moves throughout the trading day in line with the value of those underlying assets, and you can buy or sell at any point while the market is open.

In South Africa, ETFs are listed on the JSE and regulated under the Collective Investment Schemes Control Act (CISCA), which means they carry the same investor protections as unit trust funds. The JSE hosts a broad range of ETFs tracking local and global indices, sectors, currencies, and fixed income benchmarks.

How Does Investing in Exchange Traded Funds Work?

Most ETFs are passively managed: the fund manager does not pick stocks but instead replicates a published index. The SATRIX 40 ETF, for example, mirrors the FTSE/JSE Top 40 Index, holding the same shares in the same proportions as the index itself. When the index is rebalanced, the ETF is rebalanced accordingly.

The mechanics of buying are straightforward:

1. Open a brokerage or investment account. This can be a direct share trading account, an investment platform, or a tax-advantaged wrapper such as a tax-free savings account (TFSA) or retirement annuity fund.
2. Select an ETF. You choose based on the index tracked, the total expense ratio (TER), liquidity, and how the ETF fits your broader portfolio.
3. Place an order. You specify the number of units and the price at which you are willing to transact, either at market price or via a limit order.
4. Settlement. JSE-listed ETFs settle on a T+3 basis, meaning ownership transfers three business days after the trade date.

You receive dividends (or interest, for bond ETFs) in proportion to your holding, and you can reinvest those distributions manually or through an automatic reinvestment plan offered by some platforms.

Why South African Investors Use ETFs

Low Cost

Because most ETFs track an index rather than relying on active stock selection, their total expense ratios are substantially lower than those of actively managed unit trusts. A TER difference of one percentage point compounded over a 20-year investment horizon has a material impact on terminal wealth, particularly inside a retirement fund where compounding operates over decades.

Transparency

The index an ETF tracks is publicly known, and many ETF providers publish their full holdings daily. Investors always know what they own, which is not always the case with actively managed funds whose portfolios are disclosed quarterly at best.

Diversification

A single ETF can give exposure to hundreds of companies. Buying one unit of a broad market ETF is economically equivalent to holding a small slice of every constituent in the index, which eliminates single-stock concentration risk without requiring large capital.

Liquidity

Because ETFs trade on exchange, you can exit a position on any trading day. This is a meaningful advantage over certain property or private equity structures where liquidity can be restricted.

Tax Efficiency

ETFs held in a TFSA attract no dividends tax, no capital gains tax, and no income tax on interest, subject to the annual and lifetime contribution limits set by SARS. Held outside a tax-advantaged wrapper, the normal South African tax rules apply: dividends withholding tax is levied at source, and capital gains are included in taxable income at the applicable inclusion rate.

Types of ETFs Available in South Africa

ETFs and Retirement Planning

Regulation 28 and Retirement Funds

Retirement funds in South Africa, including pension funds, provident funds, and retirement annuity funds, are governed by Regulation 28 of the Pension Funds Act. Regulation 28 sets maximum exposure limits to different asset classes: equity (domestic and foreign combined), property, commodities, and private equity. ETFs that are classified as collective investment schemes qualify as permissible assets under Regulation 28, and most major ETF providers in South Africa structure their products to be Regulation 28 compliant.

This means you can build a diversified, low-cost ETF portfolio inside a retirement annuity fund and remain fully within the regulatory framework. A typical Regulation 28 compliant ETF portfolio might combine a domestic equity ETF, a global equity ETF (within the offshore allowance), a bond ETF, and a listed property ETF.

Retirement Annuity Funds

A retirement annuity fund (RA) is a private pension vehicle available to any South African taxpayer, including the self-employed. Contributions to an RA are tax-deductible up to the limits set by SARS (the rules reference a percentage of taxable income; check the current SARS tables or consult a tax adviser for the applicable figure in the current tax year). Growth inside the RA is tax-free during the accumulation phase. On retirement, a portion of the fund value can be taken as a lump sum (subject to the retirement lump sum tax tables) and the remainder must be used to purchase a pension income.

Many RA providers now offer fund options that include ETFs, either as standalone choices or as components of a model portfolio. Selecting an ETF-based fund option inside an RA combines the tax efficiency of the RA wrapper with the cost efficiency of passive investing.

Choosing Among Fund Options

When an RA or group retirement fund presents you with fund options, the choice is essentially an asset allocation decision. ETF-based fund options tend to cluster around a few approaches:

• Index-tracking equity funds: Maximum long-term growth potential, higher short-term volatility.
• Balanced or multi-asset ETF funds: Blend equities, bonds, and property within Regulation 28 limits, suitable for members who want a single, diversified choice.
• Income or bond ETF funds: Lower volatility, capital preservation focus, appropriate closer to retirement or for conservative investors.

The right combination depends on your investment horizon, risk tolerance, and whether you have other assets (such as a discretionary portfolio or a TFSA) providing complementary exposure.

Risks to Understand Before Investing

Market Risk

An ETF that tracks an equity index will fall in value when the market falls. Passive investing does not protect you from market drawdowns; it ensures you capture the full return of the index, positive or negative.

Tracking Error

No ETF perfectly replicates its index. The gap between the ETF's return and the index return is called tracking error. It arises from transaction costs, dividend reinvestment timing, and the TER. A well-managed ETF minimises tracking error, but it is worth comparing the published tracking difference figures before selecting a product.

Currency Risk

ETFs that provide offshore exposure typically do so in a foreign currency. A rand-denominated global equity ETF may hold assets priced in US dollars or euros. When the rand strengthens against those currencies, the rand value of your investment falls even if the underlying assets rise in price. Some ETFs offer currency-hedged versions, though hedging adds cost.

Liquidity Risk

While most large ETFs on the JSE are liquid, smaller or more specialist ETFs may have wide bid-offer spreads or limited trading volumes. In stressed market conditions, spreads can widen further. Check average daily trading volumes before investing in a niche ETF.

Concentration Risk in Index Construction

Some indices are more concentrated than they appear. The FTSE/JSE Top 40, for example, has historically been heavily weighted toward a small number of large-cap resource and financial shares. Tracking that index means your portfolio inherits those concentrations. Understanding the index methodology matters as much as knowing the index name.

Building a Wealth Portfolio with ETFs

A wealth fund built on ETFs does not need to be complicated. A core-satellite approach is widely used by South African investors:

• Core (70 to 80% of the portfolio): Broad, low-cost ETFs covering domestic equities, global equities, and bonds. These provide market-rate returns at minimal cost.
• Satellite (20 to 30%): More targeted positions, such as a gold ETF, a sector ETF, or an actively managed fund where you have conviction that active management adds value in that specific asset class.

This structure keeps overall costs low while allowing tactical positioning where it is justified.

Rebalancing

Over time, asset price movements will shift your actual allocation away from your target. A global equity ETF that has performed strongly may now represent a larger share of the portfolio than intended. Periodic rebalancing, typically annually or when an asset class drifts beyond a set tolerance band, restores the target allocation and enforces a disciplined buy-low, sell-high discipline.

Dollar-Cost Averaging in Rands

Investing a fixed rand amount into an ETF at regular intervals (monthly, for example) means you buy more units when prices are low and fewer when prices are high. Over a long horizon, this reduces the impact of trying to time the market and smooths the average cost per unit.

How a Financial Services Firm Can Help

While ETFs are accessible directly through online brokers, working with a qualified financial adviser or a specialist investment platform adds value in several ways:

• Portfolio construction: Selecting the right combination of ETFs across asset classes, geographies, and risk factors requires more than picking the best-performing fund over the last year.
• Tax wrapper selection: Deciding how much to invest via a TFSA, an RA, and a discretionary account involves understanding your marginal tax rate, time horizon, and liquidity needs.
• Regulation 28 compliance: For retirement fund trustees and administrators, ensuring that ETF selections remain within Regulation 28 limits as markets move requires ongoing monitoring.
• Reporting and reconciliation: Institutional investors and fund administrators need accurate, timely data on ETF holdings, valuations, and income distributions. A platform that integrates with custodians and delivers reconciled data removes the operational burden from investment teams.
• Adviser support: Independent financial advisers who recommend ETF-based portfolios to clients need tools that make onboarding, reporting, and compliance documentation efficient without adding manual overhead.

The best retirement funds are not simply those with the highest historical returns. They are funds that are appropriately structured for the member's stage of life, cost-efficient, compliant with applicable regulation, and supported by transparent reporting that keeps trustees and members informed.

Key Takeaways

Investing in exchange traded funds offers South African investors a cost-effective, transparent, and flexible route to diversified market exposure. ETFs work equally well inside tax-advantaged wrappers such as TFSAs and retirement annuity funds as they do in discretionary portfolios. Understanding the risks, including market risk, tracking error, and currency risk, is as important as understanding the benefits. For retirement planning specifically, ETF-based fund options within a Regulation 28 compliant structure can deliver competitive long-term outcomes at a fraction of the cost of many actively managed alternatives. Whether you are an individual investor building a wealth fund or an institutional administrator overseeing a group retirement fund, the principles are the same: match the asset allocation to the objective, keep costs in check, and maintain disciplined oversight of the portfolio over time.