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Here's how the Australian ETF industry is transforming

Anthony Fensom  |  27 Mar 2017Text size  Decrease  Increase  |  

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Australia might not yet have obesity (ticker: SLIM), whiskey or other weird and wonderful exchange-traded funds (ETFs) found in US markets.

But while the local market's offerings may appear dull in comparison, local funds are getting more diverse as managers seek to reach new investors.

"Gone are the days when ETP [exchange-traded product] investing in Australia exclusively meant low-cost, passive funds tracking the major equity indexes. ETPs now cover a gamut of asset classes, and include quasi-active strategies aiming to systematically exploit factors such as value and quality, for an additional cost," notes Morningstar associate director of passive strategies, Alex Prineas.

Prineas points to the growth in the Australian ETP market, which expanded to $25.45 billion in 2016, up 20 per cent from the previous year.

While not as fast as the breakneck pace of around 50 per cent annual growth from 2012 to 2015, "it's still rapid considering that flows into the broader managed fund industry were tepid in 2016," he said.

The 19 new ETPs added to the Morningstar database in 2016 followed the 33 launches of 2015, making these Australia's two biggest years for new funds.

Among those launched in 2016 included those covering such areas as cybersecurity, healthcare, Europe, and Japan, with five "active" ETPs launched that do not passively track an index.

The industry shows no sign of slowing in 2017, either. According to BetaShares, total industry funds under management (FUM) reached a new record high of $26.1 billion at the end of February, with 202 ETPs currently trading on the ASX.

BetaShares has been active in launching new funds this year, including its Global Sustainability Leaders ETF (ASX: ETHI), aimed at ethical investors, and two funds providing exposure to movements in the local currency against the US dollar.

On 22 March, the Fat Prophets Global Contrarian Fund (ASX: FPC) made its ASX debut in a $50-million initial public offering.

Millennials targeted

"Millennial" investors have also been targeted by the sector, including by micro-investing app Acorn, which allocates investors into portfolios based on ASX-listed ETFs.

According to VanEck managing director Arian Neiron, ETFs are perfectly suitable for younger investors.

"They get the instant gratification through convenience, which is one-trade, low-cost diversification to a range of investment opportunities. There are so many ETFs out there they can invest how they want or how their peers invest," he told The Australian Financial Review.

Robo-advisers are also building portfolios of stocks and bonds using ETFs to lower costs, according to the financial daily.

"Funds charging more than 1.5 per cent per year have less than a one-in-12 chance of being in the top quarter of funds over five years--and even less chance over longer periods," Stockspot's Chris Brycki told the newspaper.

Smart beta

Another emerging trend is the rise of "smart-beta" funds exposed to a factor such as momentum, or high dividend-paying stocks.

According to S&P Dow Jones Indices, smart-beta strategies now account for around 9 per cent of the Australian market, with 18 per cent of total FUM linked to indexed funds.

Of Australia's 25 smart-beta ETFs, 13 are screened or weighted by dividend.

However, Morningstar's Prineas said investors should be wary of "performance chasing" in such funds, along with their potentially higher costs.

"With a smart-beta or factor index, if that factor index is hot, such as dividend, quality, or growth, and you chase that performance, chances are you will be buying in time for that factor to go out of favour," he said.

"Smart-beta or factor ETFs also can cost more--this can be manifested in a higher management fee or hidden costs, such as portfolio turnover, which can increase trading costs and investors' tax bills."

Passive versus active

Asked about his current favourites, Prineas said Morningstar's ratings "are largely driven by the asset class and whether we think it makes sense to invest using an index fund in that class".

"For example, we like index approaches in Australian-listed property, because you've only got roughly 20 large-cap listed property trusts. There isn't a lot of room for active managers to add value," he said.

"However, the opposite of that is something like Aussie small caps, where there's a huge amount of a variety and a huge opportunity for active managers. Nearly all the active managers on our database have beaten the index, so there's not much point in going passive in the small-cap space."

Looking ahead, Prineas sees more growth ahead for Australia's ETP market in 2017, albeit perhaps not as fast as in previous years.

"Nothing is going to grow at 50 per cent per annum indefinitely, but if markets remain healthy we would expect more inflows into ETFs. This will include more factor ETFs launching, and more innovative ways of offering funds to investors," he said.

"There are a number of structural tailwinds behind inflows, such as investors wanting to reduce costs, get more transparency and convenience.

"In many ways, ETPs are a technology disruptor like Airbnb or Uber--they're offering a product at a lower cost and convenience than the older structures."

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Anthony Fensom is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. The author does not have an interest in the securities disclosed in this report.

© 2017 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.