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Keep these two points in mind when picking your next ETF

Jeremy Chunn  |  07 Jul 2022Text size  Decrease  Increase  |  
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Self-directed investors looking over the 247 exchange traded products (ETPs) on the ASX face two small problems: a big menu makes it hard to choose something good and easy-to-hide stuff that’s, frankly, a bit outrageous.

“A lot of these things look tempting but it’s important to understand what is the real investment strategy and benchmark [the product providers] are holding themselves to, and what are the risks they are taking on to exceed or match that benchmark,” says Morningstar associate director Justin Walsh, who heads research on ETFs at the Sydney office.

ETPs listed on the ASX range from vanilla passive ETFs to active funds. The costs, as annual management fees, range from 0.03% to track US Total Market equities all the way to 2.43% for a “benchmark unaware, high conviction” global equities fund. In the case of those two options, the more expensive one has lost 28% since January 1 and the cheap one is down 18% (to July 4).

Stockspot CEO Chris Brycki has watched the fast-growing ETP market and noticed thematic ETFs will always launch “around the peak of retail exuberance”, often thanks to heady media coverage. It underlines the importance of filtering out distractions and understanding the history of markets. “Issuances chase past recent returns,” he says, “and there is always a level of mean reversion in markets.”

The ETFS Battery Tech and Lithium ETF (ASX: ACDC) was the best performing ETF in 2020 with a 62% return. Investors who bought in early January 2021 are down 16% today.

Know your benchmark

It can be thrilling (or anxiety-inducing) to watch the value of a portfolio whip up and down but investors should always keep their end goals in mind. Industry benchmarks will not always align with personal goals.

However, many thematic ETFs are designed to beat a benchmark and should be judged accordingly. If they fail to do so, then it’s easy enough to match market performance by using low-cost index funds.

“We encourage investors to buy something that they understand and buy it for the long term,” says Walsh, who suggests using the S&P/ASX200 as a benchmark for local equities and the MSCI World ex-Australia (for equities in 22 developed nations, hedged or unhedged) or MSCI All-Countries World Index (which also includes 24 emerging markets) for global.

A noise-filled world

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For retail investors it can be hard to not be distracted by what others are doing. It might work out well now and then, but it can also mean watching a wildly off-balance portfolio quickly lose value when sentiment about the latest and greatest company, sector or asset class sours. “The problem is that everyone takes it hook, line and sinker,” Brycki says.

Here’s an example. A cryptocurrencies ETF that launched in November last year drew record funds for an ETF on listing and earned front-page coverage on the Australian Financial Review. Nine months later it’s down 80%.

ETF providers don’t necessarily have the same incentives as investors. Many are trying to sell products which often means a steady pipeline of new funds chasing the latest theme. Every ETF is launched on the back of a good story: the returns that would have been possible if only the product had been available.

Brycki says the ETF category needs to be tightened up. “It’s becoming looser and looser in terms of what qualifies as an ETF,” he says. “The group of products that had such a great reputation is getting tarnished with a lot of speculative products.”

It can take more than 20 years to know whether a fund manager has the skill required to beat the market, he says. Without that, “high conviction” is just a marketing term.

Jeremy is a freelance writer based in Sydney. He has previously written for the Australian Financial Review and EcoGeneration.

This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. 

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