ASIC finds ETPs tracking well but risks remain
Self-managed super fund trustees are among the most at-risk investors as exchange-traded fund inflows continue to accelerate, according to a regulatory review.
Self-managed super fund trustees are among the most at-risk investors as exchange-traded fund inflows continue to accelerate, according to a regulatory review.
The Australian Securities and Investments Commission assessed information provided by various Australian ETF issuers between January 2016 and September 2017. This covered compliance and legislation, the calculation of tracking error, arrangements around market making, and the management of conflicts of interest.
The report indicates SMSFs comprise more than 60 per cent of the total ownership of ETPs quoted on the ASX AQUA system – a platform tailored for managed funds and structured products.
Differences in spreads may significantly affect investor returns
The key concern identified was the potential for bid/offer spreads to temporarily widen, causing investors to overpay – thereby "undermining the relatively low-cost proposition of some ETPs."
"We encourage issuers to continue to educate investors and their advisers about how the ETP market operates and to provide them the tools to help them make informed investment decisions," says ASIC commissioner, John Price.
Concentration of market makers was another concern ASIC identified. Although the number of new entrants in Australia is increasing in line with market growth, most liquidity is still provided by only two entities.
"ASIC expects issuers and market operators to be aware of this risk and incorporate a means of managing it into their risk management framework," the report noted.
Market markers are an important part of the ETP framework, helping ensure there is enough liquidity for all participants.
With only a small number of market makers supporting ETPs in Australia – relative to those for equities and property securities – internal market making has become accepted practice. This creates some risks and also benefits.
Given this concentration, the key risk that the sudden withdrawal of one of these participants would have a significant adverse effect.
Lack of competition in market making may also mean that spreads - the difference between a bid and ask price – may not be as narrow as they should be.
Responding to some of the concerns ASIC raises, ETP provider VanEck emphasises the need for investors to understand how bid-offer spreads and liquidity behave in different products.
"Differences in spreads may significantly affect investor returns, therefore it is important that investors are aware of the size of the spread and understand the potential impact on their return when buying and selling ETPs," says VanEck managing director and Asia Pacific head, Arian Neiron.
He also notes the potential concerns ASIC raises around active ETFs, as a specific industry area the regulator intends to focus on next.
"Active ETFs are more likely to give investors higher spreads than ETFs which track an index … and they are not required to publish their full holdings at any time, so investors never know, at any time, what stocks or how much cash is being held in the fund.
"This can lead to higher bid-offer spreads than ETFs which track an index. If the price makers are having to guess what is in the fund, they have to set a higher spread to cover their higher risk," Neiron says.
He also suggests larger active ETF providers have an advantage over smaller players, in having "better relationships with market makers, providing better liquidity".
"ASIC's report rightly highlights that in addition to liquidity constraints, internal market making also leads to additional fees that investors need to be aware of," Neiron says.
"As the ETP pool expands and new innovations come to market, it is imperative that investors understand what they are investing in and how different ETP mechanisms operate."
More from Morningstar
• Make better investment decisions with Morningstar Premium | Free 4-week trial
Glenn Freeman is senior editor, Morningstar Australia.
© 2018 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.