ETF monthly wrap-up

Christine St Anne  |  27/03/2012Text size  Decrease  Increase  |  
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Christine St Anne: In this month's ETF wrap-up, I'm joined by Morningstar's Tim Murphy, who shares his insights into the latest trends in the market including the actively managed ETF.

Tim, welcome.

Tim Murphy: Thanks, Christine.

St Anne: Tim, firstly, can you give us an idea about who are the winners and laggards from last month?

Murphy: So, it was a big risk-on trade month in February, and so that meant some of the commodity ETFs topped the pile, specifically Silver in the BetaShares Oil ETF were at the top of the pops. With that risk-on trade, one of the common risk-on elements is the Aussie dollar, and so the flipside of that meant some of the worst ETFs during the month were some of the foreign currency exposures again, with a couple of BetaShares, currency, British pound, U.S. dollar, this sort of thing lagged and dropped during the month.

St Anne: In this month's report, Tim, you take a closer look at an actively managed ETF, can you give us an idea behind this product?

Murphy: Sure. So, there is currently no active ETFs in Australia. All the ETFs are purely passive, but there is a lot of interesting developments going on offshore in this space. Now there has been a few active ETFs in the last couple of years coming about in the U.S., but nothing has really gained a lot of traction to-date. However, on the 1st of March, PIMCO launched an ETF version of the world's largest mutual fund, the PIMCO Total Return Fund, which is a fixed interest fund run by Bill Gross, has well over $200 billion in assets in it. And so now there is an ETF version of the world's biggest fund, it�s really going to be a litmus test for where active management can work in the ETF structure.

Of course, one of the things with ETFs is the increased transparency, so publishing daily what the portfolio managers are up to, and certainly most active managers out there complain about having to provide that level of transparency to the market and fear about being front run, and there's certainly some asset classes, something - particularly like small caps, where that would be a valid concern. However, this - the world's largest mutual fund now available as an ETF is really going to be the litmus test for whether active management can play a role and can work inside the ETF structure.

St Anne: You mentioned that this product is not available in Australia, but do you expect it to be eventually offered to our investors?

Murphy: I think, at some point in the future, you're likely to see that, as the whole world is watching how this PIMCO ETF is going to track over the next year or so. It's going to be very interesting and really is going to help people make a firm decision about whether active management can or will work inside that. Because certainly then, if the world's largest fund run by probably one of the world's best known investors in Bill Gross can get away and run an ETF successfully while telling the world what he is doing on a daily basis, then it kind of dispels most fund manager concerns about being front run out there, if the world's biggest fund manager and most followed fixed interest manager certainly can get away and do it successfully.

St Anne: Is the actively managed ETF quite similar to a listed investment company or a LIC?

Murphy: They share some similar traits, however, there are certainly some important differences and it comes back to the structure, so yes, like most listed investment companies are actively managed, so an actively managed ETF you might ask, what's the difference? The important differences are the open end versus closed end structure of those, so listed investment company is closed ended, and by that I mean, does an initial capital raising, and then there is a fixed number of units on issue into perpetuity unless they do a buyback or do another capital raising.

An ETF is open ended, so that means authorized participants can create and redeem shares on a daily basis to meet the demand or supply on either side of the buy-sell trade to keep the ETF closer to the NAV, and so that's the important implication of that open ended structure for ETFs, as they�ll always trade in and around the NAV of the underlying constituents.

Whereas, anyone who has invested in LIC will know that over time given the closed end nature of it, that LIC can trade at either a premium or in some cases a significant discount to its underlying NAV, purely based on those mismatch of supply and demand dynamics in the market.

Certainly, at the moment, most of the LICs in Australia are trading at fairly steep discounts to their underlying NAV, which shows you there isn't a great demand buying for those at the moment. So, trading at 10%, 20% discounts in some cases to the underlying value, whereas, if that was an ETF structure, the market maker would quickly be able to bring that back to the close to the underlying NAV, by creating redeeming units to arbitrage that premium discount away.

St Anne: Tim, thanks so much for your insights today.

Murphy: Alright. Thanks, Christine.

 

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