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Money floods into ETFs despite ‘bubble’ warning

Lex Hall  |  13 Sep 2019Text size  Decrease  Increase  |  
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The Australian ETF industry finished the month of August at a record $54.1 billion in funds under management despite fears that a “bubble” in passive investing is distorting share prices.

Exchange-traded funds, a basket of assets that trades on an exchange like a share, received positive net inflows of $1.2 billion – a record high, according to the BetaShares Australian ETF Review – August 2019.

Inflows to fixed income continued to lead at a category level, extending the trend seen throughout this year. Fixed income received inflows for $422 million, more than double that of the next largest categories, international equities and Australian equities, which took in $196 million and $188 million respectively.

The rise occurs against a backdrop of global volatility, stubbornly low interest rates, talk of a recession in the US, and a subdued earnings season in Australia.

Since posting a record high on 30 July, the Australian share market has fallen 2.5 per cent. In the first week of August alone, the ASX 200 fell 5.4 per cent.

However, the index is up by more than 18 per cent since the start of the year.

BetaShares reports gold exposures also received strong flows and, for the second month in a row, precious metals and gold exposures were the top performers. The best-performing product during this period was the BetaShares Global Gold Miners ETF – Currency Hedged (ASX: MNRS) with a return of 15.7 per cent.

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Similarly, the VanEck Vectors Gold Miners ETF (ASX: GDX) returned 14.4 per cent, according to the VanEck ETF IQ Scorecard for August.

GDX rose more than the gold price's gain of 9.1 per cent in Australian dollar terms.

BetaShares chief executive Alex Vynokur said investors continued to see ETFs as a way to diversify across asset classes, particularly those with defensive qualities.

“We believe this is indicative of the increasing maturing of the industry, as investors continue to understand the flexibility and access benefits exchange-traded funds provide and adopt them into their investment strategies.”

Fixed income ETPs attract most flows

Australian fixed income exchange-traded products drew the greatest net flows of any asset class at $315.5 million in August, according to the VanEck ETF IQ Scorecard.

Monthly flows were the highest on record have more than doubled this year given defensive portfolio positioning, VanEck reported. 

Recession fears and a trend of global monetary easing pushed 10-year bond yields sharply lower over the month, with Australia's 10-year bond yield falling 30 basis points below 1 per cent for the first time. 

Over the 12 months to 31 August, flows to Australian and international fixed income ETPs totalled $2.8 billion, outstripping the $2.7 billion that flowed into Australian equity ETPs.

Those ETPs drew $242.4 million in net flows in August, a sharp drop from earlier months, with volatility scaring off investors from equities.

Burry's warning on 'passive bubble'

Others are less sanguine about the record flows. Michael Burry, who oversees about $340 million at Scion Asset Management in Cupertino, California, and was immortalised in the film The Big Short, fears a bubble is emerging in passive investment.

In a recent interview with Bloomberg, Burry warned the recent flood of money into index funds has parallels with the pre-2008 bubble in collateralised debt obligations, the complex securities that almost destroyed the global financial system.

Burry, who made a fortune betting against CDOs before the crisis, said index fund inflows are now distorting prices for stocks and bonds in much the same way that CDO purchases did for subprime mortgages more than a decade ago. The flows will reverse at some point, he said, and “it will be ugly” when they do.

“Like most bubbles, the longer it goes on, the worse the crash will be,” said Burry, who oversees about $340 million at Scion Asset Management in Cupertino, California.

Burry favours small-cap value stocks, arguing that they tend to be under-represented in passive funds.

BetaShares chief economist David Bassanese disputes Burry’s call, saying there is no evidence the flow of funds into ETFs has created a bubble in the equity market.

“In the GFC, there was clear mispricing of risk in the CDO market in the sense that implied mortgage default rates were assumed to remain very low,” Bassanese told Morningstar.

“To my mind, it’s not clear there’s evidence of misvaluation in equity markets, irrespective of flow. The US equity market is trading at a price-earnings ratio of 16 – only slightly above its decade average of 15.”

According to Bank of America Merrill Lynch data, passively managed funds now account for 45 per cent of US equity markets. Morningstar’s head of equity research Peter Warnes says investors are frustrated by the performance of active managers and are chasing yield where they can.

“The increasing dominance of passive funds driven by frustrated and disappointed investor-cash inflows and the underperformance of some 80 per cent of active managers has pushed equity and bond markets to heightened levels,” Warnes said in a note published on Friday.

“Are BlackRock and other index and ETF providers the owners of the penny arcades in the global financial amusement park? The investors, seeking benchmark-equalling returns in a TINA [there is no alternative] world, rolling up and spending their last dime.”

Meanwhile, BetaShares has launched three new products, including the BetaShares India Quality ETF (ASX: IIND), bringing the total number of exchange-traded products trading on the ASX to 247.

is senior editor for Morningstar Australia

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