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Why you should keep an eye on portfolio turnover in ETPs

Morningstar  |  31 Aug 2016Text size  Decrease  Increase  |  

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Portfolio turnover is an important characteristic to assess when considering an investment in an exchange-traded product.


Portfolio turnover is an important issue to consider if investors are thinking about taking the plunge into exchange-traded products (ETPs), Morningstar Australasia associate director of manager research, Alex Prineas, says in the ETF Investor newsletter for the June quarter.

"Low portfolio turnover helps minimise trading costs and tax imposts. While most passive vehicles have remarkably low portfolio turnover, this is not the case for some actively-managed products and strategic beta funds," he says.

"Before taking the plunge, investors and advisers should strive to understand an exchange-traded vehicle's investment strategy and other fundamental characteristics, including turnover, and determine what role the product will play in an overall portfolio."

Keeping a lid on portfolio turnover helps minimise trading costs within the vehicle, delays crystallising capital gains, and increases the use of the capital gains tax discount, Prineas explains.

But not all turnover is bad, he says. Skilled active managers can generate additional performance for investors by making shrewd portfolio shifts that outweigh the costs associated with portfolio turnover.

Similarly, strategic-beta ETPs may offer additional incremental returns, compensating investors for higher turnover.

However, Prineas says it's debatable whether the typical active manager or strategic-beta provider can consistently deliver enough compensating value-add to offset the additional costs associated with higher turnover.

Changes in index constituents, such as stock additions/removals or merger and acquisition activity, are the principal driver of turnover in a passive ETF. While such turnover is typically low in a passive, market-cap based ETF, this is not always the case, Prineas explains.

The adoption of a new benchmark or change to existing benchmark methodology can lead to substantially increased turnover, although this can be justified if the benefits of a new index replication methodology outweigh the costs of making the change, he says.

Fund inflows and outflows can also cause turnover, but in a well-managed ETF, these costs are often borne primarily by the buyer or seller, rather than by the existing investors.

While actively-managed exchange-traded products offer some of the convenience of investing in an ETF, there are some important differences to note, Prineas says.

Turnover is one such difference, he says, with most passive ETPs likely to have relatively low portfolio turnover, while actively-managed products or strategic-beta ETFs are likely to display significantly higher turnover.

Australia's exchange-traded product market continued to expand in the second quarter of 2016. Total ETP assets grew from $21.13 billion at 31 March to $22.35 billion at 30 June 2016, an increase of 5.78 per cent.

Product launches resumed in the second quarter after none in the first three months of the year.

Among the 10 new products were two new active vehicles from AMP Capital, created in conjunction with BetaShares, which provides operational services.

BetaShares cross-listed two WisdomTree ETFs offering currency-hedged exposure to European and Japanese equities, and ANZ ETFS launched a Euro Stoxx 50 tracker.

iShares launched hedged and unhedged Core MSCI World All Cap vehicles, and Vanguard a corporate fixed-interest index ETF.

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Alex Prineas is an associate director of manager research at Morningstar.

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