The ETF Paradox: When Buying the Market Means Buying Too Much of Too Little
Exchange Traded Funds (ETFs) have transformed investing. In South Africa, they have given ordinary investors access to shares, bonds, property and international markets without the complexity or cost traditionally associated with active investment management.
The appeal is obvious: low cost, transparency and simplicity.
Providers such as Satrix, Sygnia and CoreShares have helped make diversified investing accessible to thousands of South Africans. With a single trade, investors can gain exposure to an entire index rather than selecting individual securities.
But there is an important question investors should ask:
How diversified is an ETF if the index itself is concentrated?
Cheap doesn't always mean low-cost
ETF marketing often focuses on the Total Expense Ratio (TER). A TER of 0.30% or 0.40% can look extremely attractive compared with actively managed funds charging substantially more.
And cost matters. Keeping investment costs under control is one of the few factors investors can influence directly.
But TER is not necessarily the complete cost of ownership. Trading spreads, brokerage, index rebalancing costs, currency conversion and, in some offshore structures, underlying fund expenses can also affect returns.
These aren't necessarily "hidden fees". They are simply costs investors need to understand beyond the headline number.
Buying the market can mean buying concentration
South Africa presents another challenge.
The JSE is relatively concentrated, with a handful of large companies accounting for a significant portion of major indices. Some of these businesses also derive substantial revenues outside South Africa.
Consequently, buying a broad South African index does not necessarily mean owning a broad representation of the domestic economy.
You may own dozens of companies, but a relatively small number of businesses can still drive a large proportion of the portfolio's performance.
More holdings do not automatically equal more diversification.
Passive investing doesn't know when something is expensive
An index ETF does exactly what it promises: it tracks an index.
It doesn't necessarily care whether an individual company is attractively valued, highly leveraged or facing deteriorating fundamentals. If the company remains in the index, the ETF generally continues to hold it.
That is both the strength and weakness of passive investing.
There is no manager making emotional decisions or attempting to time the market. But there is also no active valuation discipline designed to reduce exposure to potentially expensive or deteriorating assets.
So should South Africans avoid ETFs?
Absolutely not.
ETFs can be excellent building blocks for long-term portfolios. They offer transparency, liquidity, accessibility and relatively low costs. For many investors, they can provide an efficient core allocation to equities or other asset classes.
The mistake is assuming that an ETF automatically equals a complete investment strategy.
A retiree seeking income has different requirements from a 30-year-old investor targeting capital growth. Someone concerned about inflation needs a different portfolio from someone prioritising capital preservation.
The better question isn't "ETF or active fund?"
It is:
"What job does this investment need to perform?"
Growth, income, liquidity, inflation protection, capital preservation and diversification are different objectives. No single investment vehicle is designed to solve all of them.
Cheap is valuable. But cheap isn't the same as value.
For South African investors, ETFs can be powerful tools. Used thoughtfully, they can form the foundation of a disciplined, diversified portfolio.
Used blindly, however, they can create the illusion of diversification while simply packaging the market's existing concentration and risks.
The real advantage isn't owning the market. It's understanding what you're actually buying.
Recommended ETF resources
1. JSE – Exchange Traded Funds
The best starting point for South African investors. The JSE explains how ETFs work, the different asset classes they can provide exposure to, and how investors can access them.
https://www.jse.co.za/data/etfs
2. JSE – Current ETF List & Factsheets
Useful when readers want to move from theory to actual ETF selection. The JSE provides ETF information and downloadable factsheets, including details investors can use to compare products.
https://www.jse.co.za/etf/form
3. JSE – Learn to Invest
A useful educational resource covering investing basics, brokers, ETFs and how to access the JSE. The JSE also provides guidance on verifying brokers before investing.