Who will win Australia’s ETF wars?

While listed investment companies (LICs) and managed funds struggle to attract new money, ETFs in Australia continue to boom, and industry insiders say the strong growth is set to continue.

But as “plain vanilla” ETF products reach saturation points, Morningstar senior manager research analyst Kongkon Gogoi says local provider Betashares is well placed to grow share over rivals Vanguard and iShares.

There are several reasons why, he explains: 

1. It’s primarily focused on passive investments

Passive ETFs make up about 90% of Betashares’ business. In other words, it’s a core business for Betashares, more so than it is for their competitors.

2. It’s locally based

Being Australian means Betashares can keep on top of trends and move quickly in response.

3. Speedier decision making

Gogoi thinks Vanguard and iShares are disadvantaged compared with Betashares as they’re global companies that are much larger and bureaucratic, and therefore slower to react to market changes locally.

ETFs are here to stay

Regardless of who will emerge as the biggest ETF player in Australia – the industry as a whole will continue to grow, says Vanguard’s Li-Hsia Yap.

Speaking at an Australian Shareholders’ Association event in Sydney on Thursday, Yap says while ETF growth may slow, she still expects the industry to be much larger by 2028.

Currently, there are 285 ETFs worth $140 billion in Australia. Yap believes there’ll be 400 ETFs worth $200-250 billion in five years. That would represent a compound annual growth rate of 7.4%-12.3%.

The Vanguard forecast appears realistic. Over the past ten years, the Australian ETF industry has grown 18x. Even last year, during an equity and bond rout, the ETF market had net inflows of $14.5 billion – albeit those inflows were down 34% on the previous year.

Compare that to the unlisted funds industry which saw net outflows of $27 billion last year, making it the worst ever year for Australian managed funds.

Recently, money has flowed into cash and fixed income ETFs, and out of international equities and commodities. That’s not surprising when cash and fixed income are offering their best yields in about a decade. And the outflows for international equities and commodities likely reflect their poor performances in 2022.

The Vanguard forecast for continued ETF growth also reflects the fact that the industry is still coming off a low base.

At a market size of $140 billion, ETFs only equates to about 8% of the ASX.

That’s much lower than the estimated 25% share that ETFs have in the US stock market. And Australian ETFs are still dwarfed by unlisted managed funds here, which total an estimated $3.5 trillion.

Why are ETFs so popular?

Yap believes ETFs are popular because they offer the following benefits:

1. Diversification

With ETFs, investors can easily diversify their asset allocation. 30 years ago, diversification meant holding several blue-chip stocks. Today, investors can buy a broad-based international equity product which gives you access to about 1500 developed market securities, all with one click of a mouse.

2. Low cost and low barriers to entry

If an investor wanted to invest in the top 300 ASX stocks at benchmark weights, they would need at least $300,000. And that’s not even counting transaction costs. Compare that to buying an ETF that tracks the same benchmark, which might cost less than $100.

3. Transparency

Prices and net asset values are available daily.

4. Liquidity

This refers to the ability of investors to buy and sell on the market.

Unlike direct shares whose liquidity is determined by the finite number of shares available and demand and supply of investors, the liquidity of an ETF is provided by market makers.

5. Tax efficiency

One of ETFs' most primary advantages is their tax efficiency - especially as measured relative to actively managed mutual funds.

ETFs’ tax efficiency has two sources. The first stems from strategy, the second from structure.

Which products will drive ETF growth?

Vanguard’s Yap says plain vanilla ETF products are reaching saturation point in Australia.

However, industry growth should come from specialised ETFs in areas such as ESG, alternative strategies, and active funds.

International research supports Yap’s predictions. Recently, consultancy PWC surveyed 70 ETF executives around the world and most of them expect industry AuM to reach US$15 trillion by 2027, or a compound annual growth rate of 11.8%.

They forecast most of the growth will happen in the Asia-Pacific region. And they believe three areas will drive ETF growth:

1. Active ETFs

Net inflows into global active ETFs were US$102 billion in 2022 and the industry executives believe there’s more to come. The bullish sentiment is especially apparent in the US, where active ETFs are already well established, at around 5% of overall ETF assets under management.

2. ESG

European executives are more bullish on this area than those in the US and Asia. 

3. Alternative strategies and cryptocurrency

The survey respondents cite both alternative strategies and crypto/digital asset ETFs as the nascent markets to watch. With cryptocurrency, the positive view is much more apparent in Asia and Europe, where 78% and 60% of respondents respectively anticipate significant demand ahead. US managers are less upbeat. 

In addition, thematic ETFs in Australia should continue to prove popular.

While major indexes attract the bulk of flows, sector-specific funds allow investors to back themes which are benefitting from changes in global trends. There is a wide range of ETFs which gives exposure to sectors such as gold, tech, robotics, commodities, agriculture, currencies, property, infrastructure, and cybersecurity.

Prices wars

Given the sector’s appeal, it’s no surprise that there’s a turf war to gain market share in Australia.

Earlier this year, Blackrock cut the annual management fee on its popular iShares S&P/ASX 200 ETF to 0.05%, down 44%. The fee on its iShares Core Composite Bond ETF was also reduced by a third to 0.10%.

Betashares soon followed suit, dropped the fee on its Australia 200 ETF from 0.07% to 0.04% per annum.

The moves follow a year where iShares saw outflows, with funds under management (FUM) falling 6.8% to $23.7 billion. Conversely, Betashares increased FUM by 5.5% in 2022 and market leader Vanguard’s FUM rose 7.3% to $41 billion.

Industry consolidation is a while away and, in the meantime, individual investors should benefit from fierce competition in the industry.

They can look forward to a greater variety of products, with better access, reduced costs, and - hopefully - attentive customer service.

^{An earlier version of this article contained a comment that Betashares has the best sales force in the industry. This comment was not appropriate and subjective in nature and has subsequently been removed.}