ETFs are democratising investing, says Vanguard

-- | 23/05/2019

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Glenn Freeman: I'm Glenn Freeman for Morningstar and I'm talking today exchange-traded funds with Vanguard's Head of ETFs International Axel Lomholt.

Axel, thanks very much for your time today.

Axel Lomholt: Thanks for having me.

Freeman: Well, jumping straight into it, in the current market environment we seem to be on the cusp of a fairly serious downturn. How are exchange-traded funds expected to perform during this market? I mean, I guess, they will follow whatever happens, but what types of ETFs may weather the storm better?

Lomholt: Yeah. Good question. I think the good thing for investors is that they have a broad suite of ETFs they can build their portfolios in accordance with their risk profile and risk appetite, but we would sort of generally advise people should stay broadly diversified across both, equities and fixed income.

Freeman: Yeah. It's that point I guess that they are a complementary product set rather than being an all or nothing proposition.

Lomholt: Yeah, absolutely. I mean, we think one of the more recent innovations within ETFs are fixed income ETFs and they generally serve as a great diversifier in any market scenario. And we've seen great technology supporting new fixed income ETFs. So, it's a great development.

Freeman: Now, in terms of trends within the way exchange-traded funds are constructed, it's been something of a trend in more recent times of – so traditionally ETFs have been global – they will take a global index. We've seen some of it is more region-specific. Say, some people might want to get Japanese small-caps and buy US large-caps, for instance. Is that a trend that's going to develop further and to build?

Lomholt: Yeah, it's a good question. I would say from all the clients that we engage with and talk to, there's a couple of things that's happening. The first one is that they really understand now how important low cost is in building portfolios. And they use ETFs as core holdings. So, they are probably the more broad-based fixed income ETFs. But what we've seen over the past few years is that they are now adopting ETFs more satellite exposures like the exposure that you just talked about. So, together they are sort of building low cost portfolios.

Freeman: And in Australia, in more recent times – and it's something that has, I believe, happening in other markets, too – financial advice has come into the spotlight and for the wrong reasons. Is that something that plays into the strengths of ETFs and makes them more popular? Or has it perhaps worked differently?

Lomholt: I mean, at Vanguard we think so. We think that ETFs have had a very positive impact on the financial industry, certainly in the couple of areas. They have globally disrupted distribution models. I mean, as you know, most financial (process) over the commission outside of the US And ETFs have been a wedge into these markets because they can be bought straight over the exchange. So, that's great for advisors and direct retailer clients. ETFs are democratized investing. So, people like me can buy exactly the same exposure as institutional investors. And finally, they have just lowered the costs of portfolio management overall. So, there's been a lot of benefits coming out of the recent regulatory tailwinds for sure.

Freeman: That's an interesting way of describing it as democratized assets. It was probably basically relevant here. We even got an election about – federal election next week on the weekend. But what are some of the other key areas that you see within exchange-traded funds? You alluded earlier to fixed income ETFs. Active ETFs, we've also seen at least in the Australian market coming off quite a low base, but they've been probably one of the – I think the fastest-growing segment of ETFs. Are there others?

Lomholt: Yeah, there are. So, fixed income, I'd say, is arguably the biggest innovation within ETFs at the moment. There's a couple of other things playing out. As you said, active and there's this interplay between factors and how they can sort of cheaply replicate some active exposures. There's a lot going on in thematic investing around ESG and SRI. So, we've seen a number of product launches globally in that area. Target-based investing is another theme that's playing out. And the other one is alternatives and ETFs moving into, sort of, alternatives (indiscernible) replicate some of this exposure. So, there's certainly a lot happening. We would still say that keep it diversified across all of these areas.

Freeman: When you're talking there about alternatives, what type? Are we talking private equity ETFs? Or which segments there?

Lomholt: No. I mean, there are some factors that could be replicated. It's still relatively new. But it's pretty clear that what investors are looking for is, how do I generate more return. It's a low-return environment and most of the clients that we speak to don't believe that's going to change in the foreseeable future. So, how can you build exposures that has sort of unlisted returns into a portfolio. So, we think there's a great innovation, but it would take time.

Freeman: Great. Thanks very much for your time today, Axel.

Lomholt: Thanks for having me.

This report appeared on 2021 Morningstar Australasia Pty Limited

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