introduction to beta strategies construction-beta strate… · 8 risk and performance risk is...

INTRODUCTION TO BETA STRATEGIES

14/08/2014

2

Introduction

• Investing is the trade off between risk and expectedreturn;

• In general, it is assumed that assets or Portfolios withhigher risks give a possibility of higher expectedreturns;

• Alpha Strategists (or active managers) therefore seekto provide an excess return (alpha) to the generalexpected return for the risk level of the assets beinginvested in;

• Beta Strategists (or Passive Managers) however,attempt to produce the expected return consistent withthe risk level of the assets being invested in;

• Our discussion today is around around howFund/Portfolio Managers can take advantages of thebenefits of Beta Investing in today’s world whereCapital is constantly seeking efficient utilisation.

3

The “Alpha” / “Active” Manager

2

What does the Active Managerdo?

“Times” asset class exposure to earn areturn that exceeds the returnavailable by maintaining a constantasset mix and;

Undertakes Security Selection basedon fundamental research and/orquantitative methods to earn a returnthat exceeds the return available frominvesting in the general market e.g. anIndex.

1

4

The “Beta” / “Passive” Manager

1

What does the PassiveManager do?

Attempts to match or replicateMarket or benchmark risk (couldbe Target Portfolio or Policy Risk

for Balanced Funds);

2 Beta (or Passive Managers) thusby implication, attempt to producethe expected return consistentwith the risk level of the assetsbeing invested in.

5

Lets look at a few concepts….

1

6

“Benchmarking” – The Starting Point

1 Frame of Reference: a benchmarkprovides a starting point for aportfolio manager to construct aportfolio and directs howthat portfolio should be managedon an ongoing basis fromthe perspectivesof both riskand return.

2 Performance Evaluation

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Sub-Sector

Total Market

Style Sector

Composite

Benchmark – Selection and Uses

With the vast number ofbenchmarks to choose from,deciding which one, orwhich combination of indices,to use as a benchmark canbe difficult;

It is important however, foreach Portfolio to have aclear policy statement basedon the risk and return profileof the underlying investor.

1

2

8

Risk and Performance

Risk is inseparable from Returns and pertains to the probability of earning a

return less than expected.

Beta – this measures the market riskthat is not diversifiable by measuring thestock’s/Portfolio volatility relative to themarket. The risk of any asset is afunction of how it covaries with themarket portfolio.

The standard deviation of aninvestment's expected return isconsidered a basic measure of risk. Itmeasures the dispersion of actual returnsaround the expected return of aninvestment.

http://thumbs.dreamstime.com/z/stickman-question-mark-thinking-12720187.jpg

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Efficient Market Hypothesis

Financial Markets are “informationally efficient”;

In consequence of this, one cannot consistently achieve returns in

excess of average market returns on a risk-adjusted basis, given the

information available at the time the investment is made;

Three forms of Efficient Markets are weak, semi-strong, strong.

10

Beta/Passive Strategies….

2

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A case for the “Beta” Approach

Most actively managed funds have a challenging time beating passively

managed index funds after fees. Using Morningstar’s fund database, we

examined the performance of more than 2,000 active US equity funds during the

15-year period from July 1, 1998 to June 28, 2013. Result: only 25.6% of the active funds currently in existence

outperformed their benchmarks (nearly 75% trailed the benchmark or had an insufficient track record to compare).

(www.forbes.com)

http://posercontent.com/sites/default/files/products/140410/0815/stickman-for-daz-studio.jpg

http://www.forbes.com/

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A case for the “Beta” Approach

“Equity funds were the worst performing funds. Of the nine funds

analysed, none outperformed our Agusto 40 benchmark. This

relatively poor performance is accentuated given that the funds

also failed to outperform the Nigerian Stock Exchange All Share Index (NSE ASI) and the NSE 30,

which both outperformed the Agusto40 benchmark in the review period”Source (2014 Agusto & Co. Fund

Performance Report).

13

Active Vs Passive - Should there be a debate?

“Even though the debate continues, I believe the important discuss is not which Strategy or Style is better but how to implement a flavour of both in our Clients Portfolios for the simple purpose of delivering value”

14

Beta/Passive Strategy Techniques

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15

• All securities in the index are purchased inproportion to weights in the index;

• This helps ensure close tracking;

• Higher transaction costs due to the need to buymany securities.

Indexing Strategies - Construction Techniques

Full Replication

1

• Buys a representative sample of stocks in thebenchmark index according to their weights in theindex;

• Fewer stocks purchased means lowercommissions;

• Will not track the index as closely as fullreplication, so there will be some tracking error.

Sampling

2

• Historical information on price changes andcorrelations between securities are input into acomputer program that determines thecomposition of a portfolio;

• The program will minimize tracking error with thebenchmark;

• If the historical information changes over time,the portfolio may experience very largedifferences from the benchmark.

Quadratic Optimization

3

https://www.google.com.ng/url?q=http://mysterious-kaddu.blogspot.com/2010/09/live-life-acknowledge-your-achievements.html&sa=U&ei=v_wSU8PEMYO2hQewjYHoBA&ved=0CDgQ9QEwBQ&sig2=C_7_Qx5tBy2249SnH_tE6g&usg=AFQjCNHKhZUHuzU22TR3KwSC0O05UPYM6g

16

THANK YOU

BETA Strategy Tools

Michael Mgwaba

Exchange Traded Products

Contents

• ETFs – the new generation of investing

• ETP structures

• ETFs globally

• Some growth stats and projections

• Uses and users of ETFs

• How the ETFs benefit African markets

18 | BETA Strategies 2014

ETFs – the new generation of investing

Exchange traded funds (ETFs) are open-ended

index funds that are listed and trade on

exchanges like stocks

ETFs enable investors to gain broad exposure

to

– Entire stock markets

– Specific sectors

– Different asset classes

– Investment themes

ETFs are

– Fast and efficient – real time access to

markets

– Liquid – market maker

– Convenient – single purchase gives

exposure to the whole market / market

segment

– Transparent

– Cost-effective – lower cost than other forms

of investing

Passive

products

Active investing does

not add value (after

costs)

Transparency (full

disclosure, no style

bias)

Simplicity and

consistency

Affordability-lower costs

Listed products

Liquidity (market maker;

as liquid as the

underlying assets)

Flexibility – trading at

any time the exchange

is open, in real time

Lower costs of

execution

Guaranteed settlement

– no counterparty risk

ETFs

Other advantages – diversification (markets,

sectors, asset classes), investor protection (no

credit risk, backed by physical, regulated)


ETF structure – physical based

Two major ETF structures

– Physical based (the only one

allowed in SA)

– Swap-based

First physical-based structure

introduced in 1993, when the first

US-listed tracking S&P500

(SPDR) was launched. Currently,

the majority of global ETF AUM

held in physical based ETFs

Features

– Assets held in a ring-fenced

segregated account / trust

/ring-fenced fund company

– No fund / issuer risk -

securities fully backed by

physical asset

– High level of transparency

ETF

investor

Fully

replicate

d ETF

Sec A

Sec B

Sec

C

Sec

D

Index Sec A

Sec B

Sec

C

Sec

D

=

Cash

Index

return

- Costs +

revenue

Index return Index return


ETF globally by regions


Source: Black

Rock

Global ETP Assets & Number of ETPs by Year


Source: Black

Rock

Global ETP Cumulative Net Flows


Source: Black Rock

ETP growth projections


ETF applications in institutional portfolios

Base: 41 institutional funds, 20 asset managers. Source: 2011 US ETF Study, Greenwich Associates: Institutional Demands for Exchange-Traded Funds Continues to Climb, May 2011

Uses of ETFs

Strategic Market exposure

Directional views: establish broad directional market position , use long/short trades

to implement market views

Core / satellite: achieve strategic focus

Rebalancing: correct drift in portfolio’s asset allocation or style

Completion: add uncorrelated instruments / asset classes to strategy

Tactical Interim beta: maintain exposure to given market while searching for specific market

opportunity

Cash management: able to invest cash rapidly to gain desired market exposure

Derivatives alternative: broad opportunity set of delta 1 exposures with single line

cash based settlement

Thematic: implement thematic exposures (e.g., dividends, alternatives, empowerment)


ETFs in portfolio strategies

Portfolio construction Fill allocations required by investment strategy

Improve diversification

Gain exposure to size, style, yield, sector, geography

Portfolio management Implement short-, long- term and/or neutral market views

Hard to access asset classes, themes, sector, country

Tactical Asset Allocations

Strategic asset allocation Establish core holdings

Establish single country or sector satellites

Risk control Active risk budgeting

Combine ETFs in managing total portfolio volatility or duration adjustments

in fixed income portfolios

Cash equitisation Manage inflows, outflows, transitions

Obtain a wider exposures than offered by other Delta 1 products

Exposure Exposures to markets or asset classes where one has no expertise or

operational capabilities



Several challenges facing African exchanges:

– Lack of viable investment opportunities – generally, demand far outweighs the

supply

– Securities in issue are tightly held and the secondary – exchange mediated – trade

is very thin and inefficient

– Low market liquidity

– Regulatory and system challenges

ETFs would in principle provide retail and institutional investors with an easy,

convenient and cost effective access to various assets, diversified portfolios of assets

and whole markets.

How can ETFs help in the development of

African capital markets?

How can ETFs help in the development of African

capital markets? Why started with NewGold?


The best first step instead was to start with ETFs on highly liquid assets that was

unavailable but attractive to the investors – such as NewGold. The expected

immediate benefits to the market was that:

– it would help strengthen the regulatory / control / operational framework by

implementing the proven international regulatory standards;

– it would provide immediate liquidity to the market and help satisfy the need of

investors for liquid securities

– it would provide investors with an access to previously unavailable asset classes,

thus improving diversification opportunities and reducing investment risk

Once these products are well established and the investors become better educated

about and more comfortable with investing in general and the investing in passive

investment products such as ETFs in particular, then it becomes feasible to expand

the product offering by creating ETFs tracking more liquid national / regional /

international equity, fixed income, etc. indices and offering those to the investors.

Challenges and experiences


To successfully list an ETF on the NSE, all the stakeholders like NSE, Absa Capital,

other regulators and market participants / brokers had to solve several problems

– Regulatory

Listing requirements for ETFs

Registration, reporting

Issues affecting collective investment schemes

Status of the market maker

– System / trading

Efficient market making – process, interface, systems, hedging

Settlement (different timing standards)

Efficient security transfer / fungibility

– Marketing and education – retail and institutional

Highlights

+87% % increase in AUM over last 12 m (R22.4bn to R41.8 bn)

#1 Platinum ETF in the world 4th year in a row -Risk

SA award for ETFs and RSPs

Best Performing non-sector equity ETF –5y- NewSA

1st ever Morningstar award for an ETF -ours

1st ETFs in Mauritius –NewGold and NewPlat


Absa’s ETP business in a nutshell

36% of ETFs in listed in SA are ours (16 out of 44)

21 ETFs and ETNs listed

5 Countries in Africa where our ETFs are listed

57% of ETF assets in SA are ours (R42.7bn out of R75.1bn)

7 Asset classes covered - the widest in SA

R42.7bn Total Assets Under Management

Source: Absa CIB, ETF issuer websites, Bloomberg. Asset data as of July 4,

2014


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NCRCP7.


OJONE UMORU (MRS)

SM (Legal) Collective Investment Services

Investment and Securities Act

S. 13 (h) –empowers the SEC to

register and regulate collective

investment schemes in whatever

form

ETF Rules: 543 – 554

An Exchange Traded Fund is defined as

“an undertaking which could be a unit trust scheme; an open-ended

investment company; or any other such structure as may be

approved by the Commission, that issues unleveraged securities

or units listed on a (recognized) Securities Exchange, (and) tracks

the performance of a specified security or other assets which

includes but is not limited to stocks, basket of assets, indices,

commodity prices, foreign currency rates, or any other

appropriate benchmark approved by the Commission from time

to time.” 1

1. SEC Rules as amended in 2011.

An ETF may issue/offer Units by:

an offer for subscription to qualified investors or the general public;

such other methods as may be acceptable or prescribed by the Commission from time to time.

The Commission has the discretion not to vary or allow a particular mode of Offer if it is not in the interest of investors .

Rule 249A (4)(a)&(c)

An ETF shall comply with the listing

requirements of the relevant exchange

Registration and authorization by the

SEC must precede listing of the ETF

Form SEC 6A (application form)

Prospectus

Trust Deed*

Custodial Agreement

Authorized Dealer Agreement

Vending Agreement

Incorporation documents of the fund manager, trustee & custodian

Any other material agreement

Evidence of payment of the applicable fee

*for Trust structures only

Subject to approval/registration by

the SEC prior to listing on a

Nigerian Exchange

Compliance with relevant rules on

cross border securities transaction

Confirmation of

registration/approval by the

relevant foreign authority.

Rule 249B (5)

The general disclosure requirements, and A disclaimer statement that “the

valuation approved/accepted by the Commission…shall not be considered as an endorsement by the Commission of the value of the subject assets for any other purpose”; The underlying index, securities or

asset(s) the ETF intends to track or replicate and a description of the market sector it represents; The ETF’s investment strategy (full

replication or representative sample);The Fund’s policy on investment

income;

Circumstances that may lead to tracking errors and strategies to be employed in addressing and minimizing same;

The material risks of investing in the ETF and the mitigants;

The weightings of the major components securities or commodities of the underlying index.

Procedures in relation to creation and redemption of Units;

A statement that there is no guarantee or assurance of exact or identical replication of the performance of the index (if it tracks an index);

Details of the pricing of Units;Means for obtaining update/other information on

the underlying asset

Same required for the Trust Deed if applicable

An ETF Manager is to provide the following information on a suitable/acceptable channel:

o Indicative Optimum Value (IOPV) per Unit –Daily;

o Portfolio Deposit and NAV per Unit – Daily;

o Number of Units in circulation – Monthly;

o Index level or underlying asset price (as applicable) – for the preceding day;

o The constitution of any index basket – Quarterly.

Rule 249B (8) (i)

The ETF or ETF Manager’s website;

A hyperlink from the ETF/ETF Manager’s

website to that of the relevant Exchange;

Information pages of vendors who disseminate

trading information in their ordinary course of

business;

Any electronic medium for information

dissemination provided by the Exchange.;

Any other channel approved by the

Commission.

Rule 249B (8)(II)

Institutional investors request for creation or redemption of the in creation unit sizes or multiples

thereof ETF shares known as Creation Units from the Fund Manager. This request must be in writing

Consideration for this request may be in-kind or partly in-kind and partly cash - as stipulated in

the Offer Documents

Only authorized dealers may participate in the in-kind creation/redemption process –unless the offer

documents states otherwise

Provisions/procedures relating to creation andredemption of Units are to be adequately disclosedin the Offer and constituent documents

All cost and allowable expenses must beadequately disclosed in the Offer documents.

ASSET BASIS OF

VALUATION

ALTERNATIVELY

Securities/

commodities

listed on an

Exchange

Market value Where market value does not

represent fair value then fair

value determined in good faith

may be used –as approved by

Trustee or disclosed in the

Offer documents

Nigerian Govt.

Securities

Market price -At cost & adjusted for

accrued interest

-based on amortization of

premium and accretion of

discount

-based on average price

obtained from at least 3 PMD

Rule 249 B(11)

Currency (liquid) assets Nominal value -

Any other investment Fair value as

determined in good

faith on basis verified

by the Auditor to the

Fund and approved by

the Trustee/disclosed in

the Offer documents

-

All reporting and audit requirements of a CIS

applies.

In addition:

Quarterly reports of the ETF to be published on the

Fund/Fund manager’s website within a month;

The Custodian/Depository to conduct and submit a

report of reconciliation of the Units and underlying

assets to the Commission on a quarterly basis;

The annual report to be published and distributed

to Unit holders within 3 months of the Funds year

end.

S.161 (ISA) -Illegal to deal in

unregistered units

Proposed Rule on one month window

Liquidity

The requirement of an Authorized

Dealer

Costs/tracking error implications

Investment Committee

INVESTOR PROTECTIONFund Structure

Requirement to hold full portfolio

Ensuring information dissemination

Continuous monitoring

Exchange Traded Funds : An Overview

Benefits and Risks of ETFs

ETFs in African Markets

ETFs in Nigeria

The NewGOLD & VEGIF ETF

The LHE ETF

Transaction Highlights

Strategies for using ETFs in your Portfolio

Conclusion

54

Outline

55

Exchange Traded Funds (ETFs): An Overview

Exchange traded funds (ETFs) are one of the fastest growing instruments in the world

with c.USD1.5 trillion in asset under management globally (Source: Nigerian Stock

Exchange)

An Exchange traded fund (ETF) is a security that tracks the performance of an index,

basket of assets or a commodity.

It is an open-ended passive investment fund, listed and traded on the stock exchange

just like equities.

This investment vehicle gives investors a convenient way to purchase a broad basket

of securities in a single transaction.

Essentially, an ETF offers the convenience of a stock along with the diversification of a

mutual fund in a more cost effective structure.

ETFs are classified as open-ended “Unit Investment Trusts”.

Global SceneETF UNDERLINING

INDEX/COMMODITY

EXCHANGE

SPDR S&P 500 ETF (SPY) S&P 500 index New York Stock Exchange

Lotus Halal Equity ETF NSE Lotus Islamic Index Nigeria Stock Exchange

Dow Jones Islamic Market

Turkey ETF

Dow Jones Islamic Market Turkey

Index

Istanbul Exchange

Vetiva Griffin 30 Exchange

Traded Fund

NSE 30 Index Nigeria Stock Exchange

ETFS physical platinum

ETF

Platinum HONK KONG Stock

Exchange

NewGold ETF Gold Bullion held by ABSA

Capital in South Africa but traded

on the London Stock Exchange

Nigeria Stock Exchange

56

Exchange Traded Funds (ETFs): Examples

• ETFs provide an important diversification tool forPFAs, individual investors, foreign investors andportfolio managersDiversification

• ETFs offer two sources of liquidity: Primarymarket and secondary market.

• Ease of trading on the stock exchange offersgreater liquidity

Liquidity

• Separation of fund management functionsfrom asset custody. This is in line withrecommended best practice.

• Good governance , enhanced investorsprotection and successful investmentoutcomes

Excellent Fund Structure

•ETFs can be bought and sold rapidly in response to market movements

Flexibility

57

Exchange Traded Funds: Benefits

• Some ETFs distribute returns quarterly to unitholders in the event of excess cash in the fundpool from dividends

Distributions

• As a passive fund, the ETF would havemuch lower transaction costs and fees whencompared to typical mutual funds or stock.

Lower Transaction Costs

58

STATUTORY CHARGES COMPARISM -Equities vs. ETFs

SELL SIDE

NSE

FEES

VAT ON NSE

FEES

(at 5%) CSCS FEES

VAT ON CSCS FEES

( at 5%) STAMP DUTIES

TOTAL

STATUTORY

CHARGES

Equities 0.3000% 0.0150% 0.3000% 0.0150% 0.075% 0.7050%

ETF 0.0160% 0.0008% 0.0160% 0.0008% 0.075% 0.1086%

Difference 0.5964%


59


STATUTORY CHARGES COMPARISM -Equities vs. ETFs

BUY SIDE SEC FEES

VAT ON SEC FEES

(at 5%) CSCS FEES

VAT ON CSCS

FEES

( at 5%)

STAMP

DUTIES

TOTAL

STATUTORY

CHARGES

Equities 0.3000% 0.0000% 0.0000% 0.0000% 0.075% 0.3750%

ETF 0.3000% 0.0000% 0.0000% 0.0000% 0.075% 0.3750%

Difference 0.0000%

• ETFs leverage on the fund size and the passivenature to reduce transaction costs & enhanceportfolio returns. Total fund costs includingmanagers fees are negligible 1.12% vs 3-4% formutual funds

Cost Efficient

• ETFs appoint market makers to ensure thatmarket transactions are as smooth andcontinuous as possible . This providesunitholders with liquidity whenever they want tobuy and sell.

Market Maker

Exchange Traded Funds: Risks

Risks Impacts

Market Risks Prices will fluctuate as the underlying

securities prices go up and down

Operational Risk System Malfunctioning (e.g. NSE trading

platform) may delay trading on the ETF

Secondary Trading Risk No guarantee that an ETF may create

liquidity on the secondary market. However,

the appointment of a market maker provides

a mitigant to this risk

61

Exchange Traded Funds (ETFs): African Markets

Except for South Africa with a developed ETF market (44 ETFs), The

ETF market is in its infancy in Africa

Egypt, Botswana and Nigeria are other African countries that have

explored ETFs

International ETFs have been created to track the performance of

African market stocks

Fund Name Ticker

Sub-Saharan

Weight (excl.

SA)

Frontier African

Countries Represented

Nile Pan Africa Fund NAFAX 25.1% Nigeria, Ghana

Wasatch Frontier Emerging Small

Countries FundWAFMX 23.9% Nigeria, Kenya, Ghana, Namibia

Market Vectors Africa Index ETF AFK 20.8% Nigeria, Kenya

Templeton Frontier Markets TFMAX 18.9%Nigeria, Kenya, Zimbabwe,

Mauritius, Ghana, Malawi

HSBC Frontier Markets Fund HSFAX 17.5% Nigeria, Kenya

iShares MSCI Frontier 100 Index Fund FM 15.5% Nigeria, Kenya, Mauritius

Harding Loevner Frontier Emerging

Markets PortfolioHLMOX 13.8%

Nigeria, Kenya, Ghana, Mauritius,

Senegal

T. Rowe Price Africa & Middle East TRAMX 10.7% Nigeria, Ghana, Zambia

Commonwealth Africa Fund CAFRX 4.0% Nigeria, Kenya

International ETFs tracking African Markets

Exchange Traded Funds: Nigeria’s experience

ETFs are recent innovations in the Nigerian capital market.

ETFs account for 0.0178% of the total Market Capitalization of the Nigerian

Stock Exchange. (as at 06th August, 2014)

Vetiva Capital Limited, in collaboration with ABSA Capital, a South African

investment banking firm, introduced the first ETF, the NewGold ETF in

December 2011.

Vetiva Griffin 30 Exchange Traded Fund (VG 30 ETF) which tracks the price

and yield performance of the NSE 30 was launched in March 2014.

To enable investors benefit from the historical superior performance of the NSE

Lotus Islamic Index (NSE LII), Lotus Capital has created The Lotus Halal Equity

ETF (LHE ETF) to track the performance of the NSE LII.

There is still a lot of room for growth in the Nigerian ETF market

63

NEWGOLD ETF

Year Launched : 2011

Description: The NewGold ETF was created to track the price of Gold Fix PM on the

London Stock Exchange

Sponsor: Vetiva Capital Management Limited

YtD Return: 8.09% (As at 7th August 2014); Gold Fix PM YtD Return: 8.36%

Gold Fix PM slightly outperformed the NewGold ETF by 27 basis points

64

ETFs on The Nigerian Stock Exchange

1100

1300

1500

1700

1900

1700

2200

2700

3200

3700

Nov-11 Mar-12 Jul-12 Nov-12 Mar-13 Jul-13 Nov-13 Mar-14 Jul-14

NewGold GoldFix Price

VETIVA GRIFFIN 30 ETF

Year Launched : 2014

Description: The VG30 ETF is designed to track the performance of the constituent

companies of the NSE 30 Index

Sponsor: Vetiva Fund Managers Limited

YtD Return: 13.46% (As at 7th August 2014); NSE 30 YtD Return: 2.06%.

NSE 30 has however returned 13.83% since the Vetiva ETF was listed.

65

ETFs on The Nigerian Stock Exchange

16

16.5

17

17.5

18

18.5

19

19.5

20

1650

1700

1750

1800

1850

1900

1950

2000

NSE 30 VETIGIF 30 ETF

Vetiva Griffin 30 ETF has returned 13.46% YtD return as at August 07th, 2014.

Fund expenses account for the slight tracking error with NSE30.

NSE ASI underperformed the VG30 and the NSE30 though with returns of 11.63%

since VG30 was launched.

VG30’s returns correlation to NSE 30 and NSEASI are 0.789 and 0.796

respectively

ETFs on The Nigerian Stock Exchange: VG30 vs. NSE30

Performance and Correlation with NSE ASI

0.95

1

1.05

1.1

1.15 NSE 30 VETIGIF 30 ETF NSEASI

VETIVA GRIFFIN 30 ETF

Possible Causes: Capital Gains distributions, NSE30 index changes, Cash drag,

Fund management and trading fees

NEWGOLD ETF

Possible Causes: Cash drag, Fund management and trading fees, Capital Gains

distributions, movements in the US dollar price of gold, the Rand/US Dollar exchange

rate and the Naira/US Dollar exchange rate

ETFs on The Nigerian Stock Exchange: Tracking

Errors

The LHE ETF is about to be the newest ETF addition to the Nigerian

Stock Exchange

Description: The Lotus Halal Equity Exchange Traded Fund “LHE ETF”

is designed to track the performance of the NSE-Lotus Islamic Index

(NSE-LII).

It is designed to enable investors obtain market exposure to the securities

of the constituent companies of the NSE-LII and to replicate, the price and

yield performance of the index.

Objective: To grant investors easy access to the constituent stocks of the

NSELII, especially to those who have a special interest in Shari'ah

complaint stocks.

68

LOTUS HALAL EQUITY ETF (LHE ETF)ETFs on The Nigeria Stock Exchange

Lotus Halal Equity Exchange Traded Fund (LHE

ETF)

69

NIGERIAN STOCK EXCHANGE LOTUS ISLAMIC INDEX

(NSELII)

THE INDEX: The NSE Lotus Islamic Index (NSE LII)

An equity index that tracks the performance of a basket of

selected Shari’ah compliant equities listed on the floor of the

Nigerian Stock Exchange.

2009

The index was officially launched in 2012

Adjusted Market Capitalization Weighted Index

15 screened equities with weights applied to component stocks

and sub-sectors. Each sub-sector weight is capped at 40%

while the weight of each component stock is capped at 30%.

Stocks must meet qualitative and quantitative criteria and

certified by renowned Islamic Scholars

December 31, 2009

1,000

Description

Origination

Date

Date of

Launch

Type of

Index

Component

s & Weights

Eligibility

Criteria

Base Date

Base Value

70


(NSELII)

THE INDEX: The NSE Lotus Islamic Index

The NSE LII is reviewed and rebalanced bi-annually, on the first

business day in January and July every year.

o OKOMUOIL

o PRESCO

o JULIUS BERGER

o DANGOTE CEMENT

o NESTLE

o LAFARGE WAPCO

o UACN

o CADBURY

o GLAXOSMITHKLINE

o ASHAKA CEMENT

o CHEMICAL AND ALLIED PAINTS (CAP)

o PATERSON ZOCHONIS (PZ)

o CCNN

o UNILEVER

o NASCON

Index

Review

Index

Component

Stocks

71


(NSELII)

The NSE LII’s Screening Process

o This stage eliminates any listed company that deals in prohibited

activities such as alcoholic beverages, tobacco, conventional

financial services such as banks and insurance companies,

gambling and adult entertainment.

o This involves elimination of companies with unacceptable levels of

debt, cash and interest income based on the standard of AAOIFI

(Auditing Organization for Islamic Financial Institutions)

o The quantitative screening also considers the market capitalization

and liquidity of stocks.

Qualitative

Screening

Quantitative

Screening

Screening

Metrics

Stocks in the index undergo two main stages of screening; qualitative and

quantitative

%

Debt Screen <30

Cash Screen 1 <5.00

Cash Screen 2 <30.00

Accounts Receivables <45

72

Historical Levels of NSELII

73

22.53%

41.98%

-13.60%

44.21%

61.84%

0.40%

-33.78%

18.93%

-16.31%

35.45%

47.19%

2.79%

-34.00%

-24.00%

-14.00%

-4.00%

6.00%

16.00%

26.00%

36.00%

46.00%

56.00%

2009 2010 2011 2012 2013 H1 2014

NSE LII NSE All Share Index

Historical Performance of the NSE LII

The NSELII outperforming the NSEASI

Correlation Coefficient of NSELII and NSE All Share Index is

0.76

Source: Vetiva Capital Management, Lotus Research

74

Dividend Yield and P/E Ratio of NSE LII

19.04

20.7

18

18.5

19

19.5

20

20.5

21

NSEALSI NSELII

P/E (x)

3.75%

3.82%

3.70%

3.72%

3.74%

3.76%

3.78%

3.80%

3.82%

3.84%

NSEALSI NSELII

Dividend Yield

*P/E *DIV YIELD

NSELII 19.04x 3.82%

NSEALSI 20.7x 3.75%

*Figures as at 30th June,2014

Fund Manager: Lotus Capital Limited

Issuing House: Vetiva Capital Management Limited

Trustee to the Fund: First Trustees Nigeria Limited

Custodian: Citibank Nigeria Limited (Global Transaction Services)

Authorized Dealer/

Sponsoring Broker

Vetiva Securities Limited

Transfer Agent: Central Securities Clearing Systems Plc

The Offer: 100,000,000 units of Lotus Halal Equity ETF at an Indicative

unit price equal to 1/200 of the value of the NSE-Lotus Islamic

Index on the preceding day of the Offer subscription

Subscription Method: Subscription in units in the Initial Offer may be via one of the

two ways:

1. Payment of cash in Naira

2. By the delivery of one or more baskets (i.e. Securities for

units in specie Subscriptions)

LHE ETF: Transaction Highlights

Minimum Subscription

unit:

For cash subscriptions: A minimum of 200,000 Units (i.e. a

basket of Lotus Halal Equity ETF)

For In-specie subscriptions A minimum of 5,000,000 Units

(i.e. 25 baskets of Lotus Halal Equity ETF)

Issue Price: For in specie subscriptions: the subscription price under the

initial offer shall be discharged by the delivery of 25 baskets

of the constituent securities, entitling the investor to

5,000,000 units of the LHE ETF

For Cash Subscriptions: the subscription price per unit

during the initial offer period will be based on 1/200 of the

closing value of the NSE-LII on the preceding day of the

subscription, subject to a minimum of one basket

Quotation: An application has been made to the Council of the Nigerian

Stock Exchange to list the LHE ETF

Opening Date: 15 August 2014

Closing Date: 11 September 2014

76


In-specie Subscription: In-specie Subscription simply implies an Offer for

Subscription on a “Securities for Units” basis. This means

that an investor will deliver a full block or more of the

constituents securities (25 baskets the NSELII constituent

securities) in exchange for 5,000,000 units of the Lotus

Halal Equity ETF

Application Procedures: o Investor executes application form included in the

Prospectus (subject to a minimum of 5,000,000 units and in

subsequent multiples of 200,000 units);

o Investor executes the CSCS ETF Detachment Form;

o The Investor's broker or Custodian (depending on where the

underlying shares are held) will also need to sign-off on the

detachment form;

o Investor or investor’s broker forwards the executed

Application and Detachment Forms to Vetiva;

o Vetiva reviews forms and forwards same to the Transfer

Agent (CSCS) for processing;

o CSCS detaches underlying securities from Investor’s CSCS

Account on receipt of executed detachment and application

form during the Offer Period.

o On receipt of the Allotment Approval from the Securities and

Exchange Commission, Investor’s CSCS accounts will be

credited with the ETF units.77

Transaction Highlights: In-Specie Subscription

Procedure

Transfer Agent: Central Securities Clearing Systems Plc

Investment Strategy: The Fund intends to fully replicate the NSE-Lotus Islamic Index

Policy on Investment

Income:

Investment income earned if any, less expense, may be

distributed to Unit holders quarterly,

Creation/Redemption: Investors, who choose not to trade on the secondary market,

may purchase/sell units of LHE ETF Securities through the

process of creation/redemption, subject to a minimum creation

/redemption value threshold of a block of ETF units .

Sponsor: The Fund is sponsored by Lotus Capital Limited. Lotus Capital

Limited is duly registered with the Securities and Exchange

Commission as a Fund Manager

Investment Objective &

Policy:

The Lotus Halal Equity ETF is designed for and offered to

investors seeking market exposure to the constituents of the

NSE-LII.

The investment objective of the Fund Manager in respect of the

LHE-ETF securities is to mirror the performance of the NSE-

Lotus Islamic Index


ETFs typically used as a tool to invest in a broad market index – equity, fixedincome

Buy and hold Strategy – passively move in tandem with the benchmark

Can actively manage your portfolio by buying and selling ETF according to yourviews

Core Satellite – augment your core holdings with specialized ETFs e.g. sector,commodity, ethical etc. makes your portfolio more active; or make the ETF yourcore and augment with stock picks i.e. ‘beta’ core then search for ‘alpha’

Building Blocks – for multi asset class portfolios. Simply buy ETFs for each classesin required allocation

Short Sales – ETFs can be used in hedging strategies. Any strategy that can beimplemented with a stock or bond can be applied to ETFs however, you are tradingand entire market segment with ETFs

Pairs Trading

79

LOTUS HALAL EQUITY ETF (LHE ETF)Strategies for using ETFs in your Portfolio

80

LOTUS HALAL EQUITY ETF (LHE ETF)Strategies for using ETFs in your Portfolio

Correlations of Nigerian ETFsfrom the inception date of VETGIF30 ETF: March 14th, 2014 - Aug 6th, 2014)

Source: Lotus Capital Research

Cor (VG30,NSE30) 0.78948952

Cor (VG30,NSEASI) 0.796266178

Cor (NSE30,NSEASI) 0.870944219

Cor (VG30,NSELII) 0.471445191

Cor (NEWGOLD,NSELII) 0.115090941

Cor (VG30,NEWGOLD) -0.03935275

combine the best features of mutual funds with the trading flexibility of stocks

offer diversification and low expense ratios

often improve performance - random walk theory

can be used to implement active management strategies

are easier for rebalancing – can increase or decrease equity exposure by tradingETF

are easier to monitor and understand – less complex portfolios

lower transaction costs – fewer trades, fewer stocks, fewer commissions

are typically less volatile

can be adapted to suit many investment objectives

are convenient, cost efficient and flexible. Easy to understand and easy to use.81

LOTUS HALAL EQUITY ETF (LHE ETF)Conclusion

Exchange Traded Funds -

Thank you