A while ago, I wrote ‘How to fix the JSE’ where I highlighted what problems the JSE is facing and I offered a range of solutions.
One of these solutions was to offer the South African equivalent of an ‘American Depository Receipt’ (ADR) and list single stocks of major offshore groups on the JSE (in other words, a Joburg Depository Receipt or a ‘JDR’).
While this is not quite what has happened (it still might happen, legislative willing!), FNB has quietly launched a single-stock exchange-traded note (ETN) on the JSE.
You can find the entire list and their respective pricing supplements here under the ‘Exchange-traded notes’ title.
Let me explain these notes simply:
- ETNs are notes guaranteed by the issuer’s balance sheet, in this case FNB (i.e. top-quality domestic credit risk).
- These ETNs each track a single identified stock (see list below).
- Unlike exchange-traded funds (ETFs), ETNs do not hold the underlying stock, hence this claim back to the issuer’s balance sheet creates counterparty in addition to all the normal risks of the stock being tracked.
- For some reason, FNB has structured two notes for each single stock. The one ETN (ending with a ‘C’ in its code) has no currency hedging in place and costs 1% per annum. The other ETN (ending with a ‘Q’) has hedged the rand against future movements and costs 0.0% pa (I will explain how this is expensive later).
- These notes are market-made on the JSE and, thus, you can trade into them from any JSE brokerage account, irrespective of whether you are an FNB customer or not.
- Finally, all notes have an expiry date. These notes all last for five years, with five-year renewable clauses for a further 10 years (maximum life is thus 15 years). When they expire, the notes will pay out the cash value of whatever the underlying stock is (though, note the counterparty risk highlighted above in the unlikely scenario that FNB defaults).
The current list of individual stocks that FNB has issued these single-stock ETNs for are:
- Alphabet Inc, Class A
- com Inc
- Apple Inc
- The Coca Cola Co
- Facebook Inc, Class A
- McDonalds Corp
- Microsoft Corporation
- Netflix Inc
- Tesla Inc
- Activision Blizzard Inc
- Adobe Inc
- Berkshire Hathaway Inc, Class B
- Ford Motor Company
- Goldman Sachs Group Inc
- JP Morgan Chase and Co
- PayPal Holdings Inc
- Visa Inc, Class A
Just a note about how the currency hedged ‘Q’ notes that cost 0.0% per annum to hold are in fact expensive:
When you hedge a low interest currency into a high interest currency, you earn the interest rate differential. The US 10-year bond yield of 1.5% is materially lower than our domestic 10-year bond yield of 8.6%. Simplistically, you can borrow USDs at 1.5% and park those USDs into a 8.6% yielding ZAR investment, earning a ‘free’ 7.1% return (ignoring transaction costs and other realities).
FNB is effectively pocketing this interest rate differential through hedging the ‘Q’ notes. Thus, FNB need not charge a management fee here as the net interest differential on this hedge is likely larger than the ‘C’ notes 1% pa management fee!
Finally, while these ETNs are nice and innovative, they are not quite the ‘JDRs’ I envisioned. ETNs have plenty of flaws that JDRs would not have. That said, well done to the FNB team for launching these and I look forward to many more stocks being covered (both by them and competing offerings!).
Keith McLachlan – investment officer at Integral Asset Management.