As investors race into ETFs the menu is changing dramatically

BetaShares MD Alex Vynokur. Picture: Renee Nowytarger.

It came as the largest ETF issuer, iShares, quietly broke through the $10bn in funds barrier after one of its institutional clients purchased $463 million of its S&P/ASX200 ETF (IOZ), in a single transaction.

After closing out 2016 with $25bn in total funds, Australia’s ETF sector has rocketed ahead through 2017, thanks to the growing take-up of these ASX-listed securities by retail and professional investors, including fund managers, stock brokers and financial ­advisers.

Product issuers, including i­Shares (BlackRock), Vanguard, BetaShares and ETF Securities, expect total ETF assets in Australia will surge to $45bn by the end of next year, and could even top $50bn.

That influx of investment capital will likely be driven by a raft of new ETF products being launched in Australia, with demand for fixed income alternatives continuing to rise strongly. For retail investors, accessing corporate and government bond markets has historically been difficult because of the large minimum dollar investment dollar required.

But a new suite of bond ETFs launched in our market over the past year are steadily gaining traction, and ETF issuers here are expecting much more growth in this asset class as investors tap into rising global interest rates. On the drawing board for 2018 are more floating-rate bond ETFs, in addition to more exotic products.

There are now 168 ETFs listed on the ASX, with new products being listed just about every month.

Just this week, prolific issuer BetaShares launched a new ethical ETF, trading under the ASX code FAIR, that is investing in Australian companies engaged in sustainable business activities and avoiding others deemed to be inconsistent with responsible investment considerations. It has also just recently launched an ‘‘active Australian hybrids fund’’.

Last month Vanguard also broke new ground in the Australian market by launching four ETFs that essentially operate like funds of funds.

Each ETF invests in a range of other Vanguard funds that have been designed according to specific investor portfolio asset-allocation strategies, namely conservative, balanced, growth and high-growth. Investors can now essentially build a structured ETF portfolio through a single product. Expect more of these types of products next year.

IShares Australia director Alex Zaika says product issuers are showing greater innovation, with the expansion of so-called “smart beta” ETFs. These go beyond the basic market capitalisation methodology of traditional passive index-following ETFs, and structure their stock weightings according to fundamental, multi-factor metrics such as a company’s sales, cash flow, book value and dividend payments.

Zaika points to more fixed income products in the wings, and to greater product competition generally as product issuers launch similar products to protect their market shares in different market categories. That being said, the ETF pool in Australia is extremely concentrated, with the top 10 ETFs ranked by funds under management accounting for almost half ($15.37bn) of all sector assets. The two largest funds, State Street’s SPDR S & P/ASX 200 (STW), and Vanguard’s Australian Shares Index (VAS), account for almost 20 per cent of the ETFs market alone.

Here come millennials

BetaShares managing director Alex Vynokur says he’s expecting the ETF market to evolve next year, with changes both to the spectrum of products on offer and the type of investors they attract. “The year has been a very significant year for ETFs. Investors have definitely taken notice of the ease with which ETFs can be used to diversify portfolios, and the fact that ETFs can provide access to markets they would like to access: that will be the cornerstone of the story for 2018.”

Vynokur says one distinct trend he has noticed is the growing popularity of ETFs among those in their 20s and 30s.

“I think millennials will be a very important driver of growth for ETFs; they have embraced ETFs in recent years. The early adopters of ETFs, a lot them were investors over 50 managing an SMSF, but the new wave of investors is definitely the younger generation. They’re attracted by low costs, simplicity and ease of use. They also want to invest in a way which is relevant to their lives.”

Kris Walesby, head of ETF Securities Australia, adds that unlike other markets such as the US and Europe, Australian investors are not really using ETFs as trading instruments.

“What you’re finding is that the products are not used for trading but for accumulation, as investors are investing more into them and not redeeming.

“We are at a really positive inflection point in Australia right now, where many people have said it’s a mature market. My observation is it’s anything but mature; it’s actually only just beginning to head off on a velocity of its own. That can be seen in the speed of asset growth and low redemptions as more people become adopters, often for the very first time.”

What’s most important for ETF investors is to understand what you are buying. While most ETF products track an index, and perform just as well as that index does, minus management fees and brokerage costs, other more sophisticated ETFs that adopt more active investment strategies could have higher risks attached.

Understanding the fees structure attached to each ETF is imperative, with some products now charging additional fees if they outperform the market index they are tracking. Yet, on the positive side of fees, investors are often able to pay only a fraction of 1 per cent on many ETF products. They are exceptionally cheap compared to traditional managed funds.

Tony Kaye is the editor of Eureka Report, which is owned by financial services group InvestSMART.