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3 ways to simplify your ETP strategy

Glenn Freeman  |  14 Jun 2017Text size  Decrease  Increase  |  
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With more than $27 billion held in Australian exchange-traded products (ETPs) as at March 31, 2017--up from $21 billion a year earlier--investor interest in the listed vehicles remains strong.


While the unprecedented growth in ETPs between 2012 and 2015 has slowed--inflows were up almost 50 per cent over this period, with 33 ETPs launched in 2015 alone--the 20 per cent growth seen in 2016 is still impressive.

This is particularly clear when viewed in the context of what Alex Prineas, Morningstar’s associate director of passive strategies, describes as "tepid…flows into the broader managed fund industry in 2016."

Referring to the three-year growth in ETP inflows, he says "nothing is going to grow at that rate indefinitely…[but] the market was up about 21 per cent in the year to the end of August 2016."

"But what you've got to keep in mind is the backdrop of pretty lack-lustre flows to more traditional unlisted managed funds," Prineas says.

Growing differentiation

Recent years have seen the rise of factor-based exchange-traded funds (ETF) investing, including the advent of strategic beta ETFs, which are sometimes referred to as "smart beta". Active ETFs, or exchange-traded managed funds (ETMFs), have also arrived.

"You can't just assume that all exchange-traded funds or exchange-traded products are the same or even similar.

"Inevitably with any active strategy there are going to be periods where you underperform…that's completely different from a passive approach, where you're likely to get the index returns day in and day out," says Prineas.

There are also other types of ETPs available to retail investors, beyond the more traditional “vanilla-flavours” available in the early 2000s.

As Prineas explains, “in the early years, you just had the basic building blocks of Australian equity ETFs and Australian-listed property ETFs,” with State Street among the first to offer these.

They were followed by global equity ETFs, along with those offering fixed interest exposure —both domestic and international—and global listed property. We’ve also seen the launch of more specialised ETF variations, such as those with leverage, or that have inverse exposure to the equity market, or that use derivatives to generate extra income or manage risk in some way. “BetaShares has probably been leading the way in terms of products that offer those types of exposures,” Prineas says.

Three ways to make sense of ETPs

To help make sense of the expanding menu of ETP options on offer, Morningstar subscribers can access Morningstar’s ETF Model Portfolio to guide them in constructing their own portfolio.

With oversight from Tim Murphy, Morningstar’s director of manager research, these were launched almost three years ago, in July 2014.

He explains these are aimed primarily at long-term investors, with an emphasis on more traditional passive-style ETFs, "though we do also have some active ETFs in there," Murphy says.

With three distinct ETF models—growth, balanced and moderate—each is differentiated across the risk/return spectrum, and with slightly different investor time horizons.

As at 30 March, 2017, the Morningstar ETF Growth Model Portfolio held 70 per cent exposure to growth assets (equities and listed property).

"This suits investors with a minimum seven-year timeframe…some capital stability is still desired, but the primary concern is a higher return, hence the 70 per cent exposure to growth assets," Murphy says.

The Morningstar ETF Balanced Model Portfolio is split 50/50 between growth- and income-oriented exchange-traded products.

"This suits investor with a minimum five-year timeframe, or those who seek both income and capital growth…who are willing to accept moderate investment value volatility in return for commensurate potential investment performance," Murphy says.

The Morningstar ETF Moderate Model Portfolio, with 70 per cent exposure to income assets (cash and fixed interest) suits investors seeking "a low level of investment volatility, and therefore a lower potential investment performance," says Murphy.

"This suits investors with a minimum three-year timeframe, or those who primarily seek income with some potential for capital growth."

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Glenn Freeman is a senior editor at Morningstar.

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