Why Investing in Regional ETFs Might be a Good Replacement for Individual Stock Investment?

Investing in ETFs has never been easier, more cost-effective, and less risky. To give an example of this, we decided to bring you an overview of the SBITOP index (for which there’s an ETF available, 7SLO ETF) compared to investing in individual stocks in the index.

With the stellar performance of the Slovenian capital market in 2021, looking at how well the SBITOP performed compared to its individual constituents is worth it, not only from the returns perspective, but also from the risk, and cost perspective. In 2021, SBITOP index had a return of 39.8%. Of the 9 constituents of the index, 8 had a positive double-digit return, while 1 had a negative return. Ouf of these, 4 (NLB, Petrol, Sava Re, Cinkarna Celje) had returns higher than the index itself, at 66.4%, 56.3%, 50.8%, and 45.5%, respectively. At the same time, out of the remaining 5 companies, 4 of them (Luka Koper, Krka, Telekom Slovenije, and Triglav), yielded returns of higher than 20%, at 32.6%, 29.1%, 28.9%, and 22.6%, respectively, while KD Group was the only one to experience a decrease ( -19.3%).

SBITOP vs. SBITOP constituents performance in 2021 (%)

However, this is only one part of the story. Even though some of these companies had really strong returns in the year, one should also take a look at how many days did they actually outperform/underperform compared to the index. Here we can see a different story. None of the companies actually outperformed the index when the total number of days is looked at, with the highest return stock (NLB) outperforming the index exactly half (50%) of the days. At the same time, the only negative return stock (KD Group) outperformed the index by only 40.9% of the days. For the vast majority of the remaining days, however, these companies underperformed the index. So what does this tell us? Two things. First of all, 2021 was a stellar year for the Slovenian capital market, in terms of returns, but only on the days, these individual companies outperformed the index. This means that secondly, investing in the SBITOP index could be as effective as investing in individual stocks if one wanted to invest over a longer period of time. This also supports the fact that as individual investors, it is really hard (almost impossible) to „time“ the market really well for a prolonged period of time.

Performance in terms of days SBITOP vs. SBITOP constituents in 2021 (%)

*Companies’ numbers will not add up to 100%, due to there being days where companies performed the same as the index

One has to be very knowledgeable (or lucky) to find a really good company that can consistently give good returns, or rather, better returns than a whole index. And then one would still have to bear company-specific risk. At the same time, if we were to invest in a couple of stocks instead of one, and thus „diversify the risk“ but choose not to invest in an index (which would do this for us), you would still be bearing a specific risk of these few companies. This is where CAPM (Capital Asset Pricing Model) shows its usefulness, and you can look for a beta of each individual stock to see how much risk this investment would add to a portfolio that looks like the market. If a stock is riskier than the market, it will have a beta greater than one. If a stock has a beta of less than one, the formula assumes it will reduce the risk of a portfolio. Adding beta to the formula assumes that risk can be measured by a stock’s price volatility, but in fact price movements in both directions are not equally risky. Beta does not account for the relative riskiness of a stock that is more volatile than the market with a high frequency of downside shocks compared to another stock with an equally high beta that does not experience the same kind of price movements to the downside. All of this should be taken into account when building a portfolio.

So if one would be willing to make their own portfolio, one would also have higher inherent costs to each transaction (such as broker fees, custody fees, dividend taxes if the stocks have dividends, among others). Even though this can yield good results for some of the time, it does not take into account one other cost: the capital gains tax. This tax refers to the 10% tax (and the city surtax charged on this 10% depending on where you live) for any investment that’s cashed out within 2 years period after it was made. But one might say that this tax is charged on all capital gains, SBITOP included. Well here we come to the crux of the issue: Since individual stocks have higher risks (but also higher returns) one might be tempted to “cash-out” earlier if something goes wrong with a stock they have a position in, having to pay the capital gains tax. Owning a diversified index like SBITOP can lower that temptation (and also the risk), which means that in the long-term, it would yield higher returns. Considering the fact that we have a positive outlook on the Slovenian capital market for 2022 (good dividend yields, returns, higher liquidity, etc.), investing in a benchmark of the market (SBITOP index) can be a good idea.

Of course, you could say that investing in index funds has been available for a long time now, so what’s the point? Well, you have to take into account that index funds are actively managed by fund managers, meaning that even if we would select an index fund over one or several stocks (and get all the benefits we mentioned above), one would still have to pay some fund-specific fees (depending on the fund, like entry fees, exit fees, management fees etc.) This fees all add up, while exit fees are usually wiaved by the fund if investor stays in the fund for more than two years.

This is where an ETF like the 7SLO comes in handy. Since it is a passively managed fund (only following the underlying assets of the SBITOP index in the percentage they are present in the index), the inherent costs are lower. At the same time, since it’s a composite of stocks, it diversifies the risks. Lastly, the 7SLO ETF is based on the total return policy. This means that any dividends that are paid out by the companies which compose the Index are directly reinvested. This creates even higher returns and avoids the dividend tax if one were to own these stocks individually, even in the same weight as the SBITOP index. All of this means that an ETF like the 7SLO can give you the best of all worlds. In 2021 7SLO combined it all: good returns and dividend yields of Slovenian companies, lower risk through diversification, lower overall costs, and a chance to invest long-term, without a hassle. To learn more about the 7SLO ETF, click here.

Category : Blog

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