Mythbusting ETFs

Exchange traded funds (ETFs) have exploded in popularity with the total value of the Australian exchange traded products (ETPs) industry surpassing $56 billion, and it is expected to reach the $60 billion mark by the end of the year.

It has become a great tool for advisers who want to get clients a taste of certain exposures, including different stock exchanges, indicies, bonds, commodities and currencies.

Since many ETFs have reliably outperformed active managers, with much lower fees, it’s made them an attractive choice for investors and financial advisers.

However, as with all trends and disruptions, there is often conflicting information given about these type of products.

ACTIVE V PASSIVE 

It has been argued whether active ETFs should be described as ETFs at all, if they are actively managed rather than passively tracking an index.

Kris Walesby, ETF Securities Australia chief executive, described himself as a big of fan of active ETFs as it gave investors more choice by allowing people to get access to what would’ve usually been unlisted options.

“To me the debate about active ETFs is around a number of active managers who have failed to outperform an index over time, in which case people are paying a lot of money to get not much out of it,” Walesby said.

“ETF investments can be highly active and I’m not talking about the individual ETFs but the asset allocation choices which, even if you only use passive ETFs, is active.”

Alex Vynokur, Betashares chief executive, said there is a place for both active and passive, and the debate is a waste of time as it detracts from the big picture.

“Getting the big picture right is what’s most important and that’s getting asset allocation right, research over many decades has shown asset allocation drives over 90% of investors returns,” Vynokur said.

“We need to be focused on building the right portfolios for clients, and if they are getting diversified, cost-effective portfolios then that’s really the big prize.”

For investors the perception is reality, and they see ETFs as low-cost, transparent and that it followed an index, said VanEck managing director and head of Asia Pacific Arian Neiron.

“We find we’re persistently educating all types of investors and advisers that this active exchange traded product, which can be labelled from a marketing perspective an active ETF, but it is legally characterised by ASIC and the ASX (Australian Securities Exchange) as a managed fund, [but] is being dressed up as an ETF,” Neiron said.

“We’ve had investors in conferences come up to us [to say] ‘oh, I’ve underperformed in X product and I’ve looked at the fees and the fees are so high, it’s an ETF so I don’t understand why this has happened’, but it’s not an ETF.”

Chris Meyer, head of listed investments at Pinnacle Investment Management said active and passive strategies should be able to co-exist in the market.

“I don’t think the passive industry should own the ETF moniker… there’s nothing about exchange traded funds that suggests it’s an index tracking fund,” Meyer said.

“The ETF part relates to the fact that it’s traded on an exchange, so active ETF is perfectly fine as a term for an active fund traded on an exchange.”

Christian Obrist, head of iShares, BlackRock Australia, said it’s not about active versus passive but a combination of both, and everything is an active decision when you build a portfolio.

“When you make the decision to buy 30% of your portfolio in ASX 200 ETFs, that’s an active decision, because you could have made it 35% or 25%,” Obrist said.

“You specifically decided to build that part of your portfolio with that exposure, in that weight, and in general we just believe there’s space for both.”
ASIC pause 

In July, the Australian Securities and Investments Commission (ASIC) asked market makers to exclude any new managed funds which failed to disclose their daily portfolio holdings and to use internal market makers while it conducted a review.

Vynokur said the pause was a positive and should be beneficial to the industry for the long-term.

“Active ETFs have definitely been growing fast and the regulator is clearly taking the opportunity to take a look at some of the recent growth,” Vynokur said.

“The barriers to entry in traditional index ETFs are pretty high, and barriers to entry on the active side should be the same, so we definitely welcome the pause and the review taking place.

“In the scheme of things, a pause of a few months is a little blip in the context of the significant opportunities the ETF industry has.”

Meyer said it’s an issue close to him and that he thinks there is nothing wrong with the active ETF industry.

“Any new industry that may be growing quickly where the regulator doesn’t have a good grasp of what’s going on needs to pause and have a look at it,” Meyer said.

“I would say it’s probably a healthy check but as long as it doesn’t take too long for ASIC to reopen the market.”

He said it needed to be done quickly without putting the industry at risk of investors and brokers losing interest as it was just taking off.

Walesby said the pause was a big issue, but it’s important to assume ASIC was given the benefit of the doubt they were doing it for the right reasons.

“Unless ASIC becomes comfortable with fund managers using internal market managers to protect their IP [intellectual property], which personally I think is unlikely,” Walesby said.

“Or another solution is found which allows active fund managers to not show their IP but satisfy ASIC requirements around price discovery and fairness to all investors, which could happen.

“That’s what the SEC [Securities Exchange Commission] in America has been working on for a long time, at some point a solution will be found there and that could work for Australia.”

Obrist said BlackRock advocated for the right framework for a healthy eco-system for good product development.

“That way you get products that meet investor demands, that are understood by clients and lead to good investor outcomes.

“Looking back at the framework that was in place, we had some concerns about the transparency and conflicts of interest, but we’re not against active ETFs.”

IMPACT ON MARKETS

The rise of ETFs had meant more inflows into ETF products, theoretically at the expense of actively-managed funds.

As with any change or disruption, there were fears ETFs would have too much effect over the market, artificially distorting its valuation as it throws money at indicies rather than stocks.

Walesby said the myth about market impact was one that has always irritated him.

“On the whole, there are exceptional circumstances where ETFs, especially ETFs trading in certain markets under certain conditions, do not work perfectly,” Walesby said.

“There’s been maybe three or four instances in the last 10 years where prices have declined rapidly and that’s not so much about the ETFs, it’s around the high frequency traders that are market making the ETFs.”

Obrist said the impact on markets was misunderstood and there often needed to be education for people to understand the actual impact.

“You shouldn’t be misguided by reading in the paper that ‘28% of US equity trading on exchange comes from ETFs’, because that is secondary market trading,” Obrist said.

“That is not impacting the underlying markets where you know the ETF is creating and redeeming units and essentially putting pressure on those underlying stock or bonds, it’s happening on the exchange.

“For every dollar that trades passively, roughly about $28 is traded actively.”

Vynokur said in Australia some 80% of investment was actively managed, so it was still a long way from being overtaken by passives.

“Passive differs very significantly, there are varieties in the types of indices, you can see market capitalisation, equal weight, small or large cap, so all of them are adding to the variety in the market,” Vynokur said.

Meyer said index tracking wasn’t purely just ETFs and there are massive index-tracking funds in the institutional space, as well as unlisted index-tracking funds.

“People confuse ETFs with just passive index-tracking, which is much bigger and broader,” Meyer said.

“ETF ownership of the global equity market is tiny, less than 3%, so it’s hard for me to believe ETFs flows on their own have driven the market.”
Could self-directed investors overtake financial advisers?

Vynokur said there was already a significant extent of participation from individual investors, which had been happening for some time but had now accelerated. 

“In terms of individuals, who are un-advised or are SMSF investors who buy ETFs to not have a financial adviser, that creates a tremendous opportunity for financial advisers to provide advice on ETFs,” Vynokur said.

Neiron said he doesn’t expect to see self-directed investors overtake intermediaries, but the usage of the term ‘self-directed’ was ambiguous as there is a spectrum of what may be considered under the term.

“A lot of the clients that we see come to VanEck, by way of example, they’re self-directed but they work with a stockbroker,” Neiron said.

“They’re not necessarily doing it on their own independently, they’re doing it within a microcosm of influences and that includes their accountant as well.”
Meyer doesn’t expect either advisers or self-directed investors to become the dominant force.

“If you look at most ETFs providers in Australia and you ask them how is your client-base split today and what do they expect in the future, most of them would say it’s a combination of advisers, stock brokers and self-directed investors,” Meyer said.