ETF Investor | December Quarter 2019
Undoubtedly the growth in assets and number of Australian exchange-traded funds over the past 10 years shows the enormous appetite for these investments.
Mentioned: BetaShares Australian Sustnby Ldrs ETF (FAIR), BetaShares Western Asset Aus Bd ETF (BNDS), Schroder Absolute Return Income ETF (PAYS), ActiveX Kapstream Absolute Ret Inc ETF (XKAP), BetaShares Global Sstnbty Ldrs ETF (ETHI), iShares S&P/ASX Div Opps ESG Scrnd ETF (IHD), Magellan Global Equities Currency H ETF (MHG), Magellan Infrastructure Ccy Hdg ETF (MICH), Russell Inv High Dividend Aus Shrs ETF (RDV), SPDR® MSCI Australia Sel Hi Div Yld ETF (SYI), iShares Edge MSCI World Multifactor ETF (WDMF)
What a year! Oh wait, what a decade! Undoubtedly the growth in assets and number of Australian exchange-traded funds over the past 10 years shows the enormous appetite for these investments. Let’s go back in time to the beginning of 2010.
We can see from Exhibit 1 that the Australian ETF market had AUD 3 billion in assets spread across 27 products. This is a far cry from December 2019—with assets growing 20 times (reaching AUD 61 billion) and investment products increasing more than 8 times (to 213).
Exhibit 1: ETF market growth in assets under management (LHS, in millions) and number of products (RHS) over 2001–19
Source: Morningstar Direct
Over the past decade, 186 products were launched. We also witnessed the birth of active ETFs and strategic (smart-beta) ETFs, which was barely conceivable in 2010. So, if history doesn’t repeat itself but often rhymes (according to Mark Twain), it’s likely we will continue seeing the same growth in ETFs over the next 10 years. While we don’t have a crystal ball to predict the future, let’s have a closer look at what happened with ETFs in 2019 and over the past decade and see if these trends are sustainable.
The Australian ETF market finished 2019 breaking through AUD 61 billion in assets. This represents growth of 52% over one year—an astonishing result. Twenty-two new products were added to Morningstar’s database in 2019, and the overall number of ETFs rose from 191 to 213. Exhibit 2 shows the new launches. It’s evident that new products reflect a wide range of equity, fixed-interest, multisector, and real estate ETFs. Interestingly, the mix between traditional index-tracking and active ETFs was quite balanced.
Exhibit 2: ETF product launches in 2019
Source: Morningstar Direct
A lot of interest in fixed interest
Fixed-interest ETFs are a relatively new concept to the local market, there were none listed in 2010 (Exhibit 3). With more AUD 4.3 billion in flows to those products in 2019, a lot has changed. There were five new products launched in 2019, attracting AUD 123 million; two of the five were active fixed-interest ETFs (Schroder Absolute Return Income (CHIA: PAYS)) and ActiveX Kapstream Absolute Return Income (CHIA: XKAP)) after the first (BetaShares Legg Mason Australian Bond ETF (ASX: BNDS)) was launched in 2018.
Such interest might be due to the strong performance from both the Australian and global fixed-interest markets; the Bloomberg AusBond Composite 0+Yr TR and Bloomberg Barclays Global Aggregate TR Hedged AUD indexes returned 7.26% and 7.19%, respectively, in 2019. And with global central banks keeping interest rates low in conjunction with the promise of lower fees for passive vehicles, demand for fixed-interest ETFs could persist. Exhibit 4 shows that investors had access to 30 fixed-interest ETFs as at December 2019.
Exhibit 3: Number of Australian ETFs by asset class in January 2010
Source: Morningstar Direct
Exhibit 4: Number of Australian ETFs by asset class in December 2019
Source: Morningstar Direct
Rise of active
The growing prominence of active ETFs is worth highlighting as active managers have increasingly looked to exchange-traded vehicles as a way to distribute their strategies. In 2019, we saw nine new active ETFs added to Morningstar database, representing 41% of all new launches (45% was in passive ETFs and 14% in strategic-beta ETFs), and it was a similar story in 2018.
Although the number of active ETFs is increasing year on year, the assets they are attracting are highly concentrated. Magellan pioneered the active ETF space since launching its flagship fund as a listed product in 2015, and Magellan Global Equities ETF (ASX: MGE), and Magellan Global Equities (Currency Hedged) (ASX: MHG), and Magellan Infrastructure (Currency Hedged) (ASX: MICH) have the lion’s share of assets with AUD 2.4 billion out of a total AUD 5.3 billion across all active ETFs (as of December 2019). A big part of Magellan’s success has been due to it’s attractive long-term returns.
This leaves AUD 2.9 billion shared among 41 other strategies. There are several factors constraining their growth. Investors remain cost-conscious given that the average management fee for an active ETF is 0.77% (as of December 2019, according to Morningstar Direct) compared with 0.36% for passive funds.
Plus, they typically come with a higher bid-ask spreads. Active ETFs remain a relatively new concept, hence, some investors need some time to familiarise themselves with these products.
Lastly, the lower levels of transparency can be an issue for some; active ETFs usually delay their portfolio disclosure. However, there is a trend toward increasing transparency as BNDS was the first to offer daily transparent portfolios, and XKAP does the same. In general, Morningstar applauds greater transparency.
Sustainability products are trending, or are they?
Sustainability-focused products were not as successful in capturing broader investor interest as their active counterparts. After UBS launched six region-focused ethical ETFs in 2015, only nine new products have been launched since, and they’ve only accumulated AUD 1.6 billion in total assets.
Similar to active ETFs, assets are concentrated in two strategies—BetaShares Global Sustainability Leaders (ASX: ETHI) and BetaShares Australian Sustainability Leaders (ASX: FAIR), which have 58% of the sustainable assets. This mild take-up could be due to the lower penetration of environmental, social and governance strategies into portfolios, a lack of familiarity with the product set, their relatively short performance histories and fee levels higher than their passive peers.
Despite this, we see increased investor interest toward them going forward. Currently, Morningstar provides qualitative research on ETHI, the largest sustainability-focused ETF.
Strategic beta is in vogue
There is a long list of monikers to describe ETFs that are neither traditional index-tracking funds nor active management: smart beta, factor-based, rules-based, enhanced index, and fundamental index—what we call strategic beta.
This so-called middle ground between passive and active is becoming more popular, and product providers are responding to the demand with a dizzying array of options.
The first strategic-beta ETFs were launched in 2010 by Russell, iShares and State Street (Russell Investments High Dividend Australian Shares (ASX: RDV), iShares S&P/ASX Dividend Opportunities ETF (ASX: IHD), and SPDR MSCI Australia Select High Dividend Yield (ASX: SYI)). All three aim to provide exposure to companies with higher dividend yield. Since then, the variety and complexity of strategic-beta ETFs has increased.
For example, some strategic-beta ETFs provide exposure to a specific factor (quality, wide moat, and so on), while some products (iShares Edge MSCI World Multifactor ETF (ASX: WDMF)) combine multiple factors using an optimiser, making the process opaque and complex.
While there are fewer strategic-beta ETFs compared with the active cohort, their cumulative assets are around AUD 7 billion. We believe that the growth in strategic-beta ETF popularity is here to stay, with cost playing a major role.
The average fee for a strategic-beta ETF is 0.44% (as of December 2019, according to Morningstar Direct), which is only 0.06% higher than its traditional passive rival. Another attractive feature of strategic-beta ETFs is that they allow investors to build portfolios that are more in line with their investment objectives. Morningstar currently provides qualitative research on 11 strategic-beta ETFs.
Based on current trends, we expect ETF product growth to continue, particularly in active and strategic-beta strategies. However, it’s equally likely that the long-running products will continue to draw the most flows, which may result in some products becoming unviable. We remind investors that each product is unique and requires sufficient research to determine its merit and suitability to a portfolio.
Morningstar provides qualitative research on 71 ETFs, which account for around 77% of all invested assets. As the ETF market evolves, Morningstar will ensure that its coverage reflects investor appetite and the best available options. Morningstar Premium members can get access to our research reports at premium.morningstar.com.au.