SMSFs and ETFs: A marriage made in heaven?

Anthony Fensom | 30 Nov 2017

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Self-managed super funds' love affair with exchange-traded funds has reignited, according to the latest data. Yet with the growing number of investment products on offer, will the passion continue?

Trustees' desire for ETFs is shown by the fact that until around five years ago, SMSFs made up half of the investors in Australian-listed ETFs. While the proportion has declined in recent years to around 40 per cent as such products have become more mainstream, SMSFs remain a key driver of the ETF market.

According to the "2017 Vanguard/Investment Trends Self-Managed Super Fund Reports," some 125,000 SMSFs plan to invest in ETFs in the year ahead, with 80,000 intending to reinvest in such funds. The figure was up on the previous year's 99,500 and 61,500, respectively.

The survey also found that 45,000 SMSFs were planning to make their first such investment in ETFs, with passive international equity funds the most popular option among trustees. The research was based on online surveys of more than 4,000 SMSF investors and financial planners.

Key reasons

Morningstar's associate director, manager research, Alexander Prineas, says SMSFs' long-lasting passion for such products is no coincidence.

"I'd group it into four key reasons: convenience, low cost, transparency, and access," he says.

"By convenience, they're ASX-listed and you can get a diversified portfolio in a single security, while most are very low cost. They're transparent, which is particularly appealing for investors to see how the fund fits into their existing portfolio in terms of complementary exposure.

"And you can access asset classes that SMSFs might not be able to access easily, such as bonds or global equities."

BetaShares' Alex Vynokur also suggests that SMSF investors can achieve a superior after-tax return from passive ETFs, such as those that track the S&P/ASX 200 index. This compares with actively managed funds that buy and sell shares frequently, adding to tax and trading costs.

"We think investors can be their own worst enemy if they're over-trading, and that applies to ETFs," Morningstar's Prineas says. "Investors should consider brokerage and bid-ask spreads, as these also add to the cost."

"And while a lot of people know of ETFs being simple, low-cost index funds, you also need to be aware that there are more complex and higher cost products out there, so don't assume they're all simple and low cost."

As an example, he points to the iShares S&P 500 ETF (ASX: IVV), which has an "astonishingly low" annual fee of 0.04 per cent, making it the nation's cheapest ETF. Morningstar ascribed a "Gold" rating to the fund in November 2016, describing it as "one of the best ways to access US equities".

In contrast, the annual fee for the iShares S&P/ASX Small Ordinaries ETF (ASX: ISO) is 0.55 per cent. Morningstar assigned a "Neutral" rating to the fund in November 2016, describing it as a "capable product that passively tracks the index," but in a sector where active managers have traditionally outperformed.

SMSF growth

The continued growth of the SMSF sector is likely to be a boon for ETFs. Despite regulatory and investment uncertainty, SMSF assets rose 8 per cent to $645 billion in fiscal 2017, the largest annual rise in three years, with the number of such funds increasing by 4 per cent to 585,000.

"SMSFs were one of the early cornerstone investors in ETFs, however these days you have more variety in the user base, from institutional investors to millennials, with these younger investors accessing ETFs either directly or through robo-advice or online products," Prineas says.

"Overall, this is beneficial since the bigger the user base, the more liquid the funds are, the more diverse the trading in the product and the lower the management fee that can be offered."

The ETF industry's growing maturity in Australia is seen in the range of funds available covering all the major asset classes, including Australian and global equities, bonds, and listed property along with active funds. This has resulted in a slowing of new product launches, which reached around 40 a year in 2015 and 2016.

"A lot of the building blocks are available now, so the launches are more specific and more targeted," Prineas says. "While it's growing for now, ultimately there will be some big winners and some losers, so we expect some consolidation in the sector."

Overall, Prineas sees ETFs maintaining their advantage in areas such as cost, amid regulatory pressure for greater fee disclosure, although their edge in transparency could be challenged.

"One area where an advantage ETFs have which might erode is in transparency, since there is legislation being debated about forcing more portfolio disclosure," Prineas says.

"In a competitive environment, fund managers will want to improve their disclosure, so the advantage there held by ETFs could erode over time, although it's more of a medium to longer-term phenomenon."

Yet with SMSFs increasing their investment firepower, the ETF market is likely to remain closely attuned to the needs of such investors for some time to come.

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Anthony Fensom is a Morningstar contributor. 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. The author does not have an interest in the securities disclosed in this report.

© 2017 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.

This report appeared on www.morningstar.com.au 2022 Morningstar Australasia Pty Limited

© 2022 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 content 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.