After a slow start, the issuers of exchange-traded funds in Australia are convinced they’re on the cusp of rapid growth and widespread acceptance by financial planners and their clients. Simon Hoyle reports.
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In the US in the space of a few short years, the popularity of exchange-traded funds (ETFs) has exploded. From just a few dozen of these sharemarketlisted vehicles 10 years ago, there are now more than 1700, with a combined value of $US790 billion ($1 trillion), and the numbers continue to climb rapidly.
The first ETFs in the world were launched not in the US, but in Canada. The funds have been available in Australia since 2001, when State Street Global Advisers (SSgA) launched its ETF range, and then through iShares, a division of Barclays Global Investors (BGI, recently sold to BlackRock). In May this year Vanguard entered the local market, taking the number of ETFs available to Australian investors to 25. SSgA and Vanguard each offer three ETFs, while iShares offers 19. These ETFs offer local investors a range of different exposures to equity markets here and overseas.
A BGI report on the global ETF market at the end of June 2009, said iShares is the largest ETF provider in the world, in terms of both number of products, with 386 ETFs, and assets of $US380 billion, and a 48 per cent global market share. It said SSgA is second with 104 products valued at $US120 billion, and a 15 per cent market share. And Vanguard is third, with 40 products valued at $US60 billion, and a 7.5 per cent market share. The growing willingness of financial planners to consider ETFs as a low-cost, tax-efficient way for clients to gain broad sharemarket diversification prompted Vanguard’s recent entry, and is likely to attract additional issuers in coming months and years. ETFs make sense in an investment portfolio for exactly the same reasons index funds already make sense for many investors.
Designed to replicate the performance of a particular market index, ETFs aim to do so faithfully, but at very low cost – lower, even, than existing, unlisted index funds – and with a high level of tax efficiency, by minimising portfolio turnover, and hence minimising both transaction costs and potential capital gains tax (CGT).
“The philosophy around indexing is that it’s a low-cost way to achieve a highly-diversified exposure to a market,” says Robyn Laidlaw, ETF product manager for Vanguard in Australia.
“The low-turnover approach that is typically associated with indexing is consistent with a taxefficient approach to investing.”
ETFs are like the proverbial duck: On the surface all seems serene and simple; below the surface there’s a bit more going on. Financial planners and retail investors will generally only ever encounter ETFs “above the waterline”, as it were, in the so-called secondary market.
This is where units in ETFs are traded, in exactly the same way as listed equities, on the Australian Securities Exchange (ASX).
“Below the waterline”, the so-called “primary market”, is the preserve of market-makers and authorised participants. These are generally broking firms, who have entered explicit agreements with the issuers of ETFs to create liquidity and drive the mechanisms for issuing and redeeming ETF units directly with the issuer. In the primary market, brokers create a “basket” of stocks that mirrors the composition of a given ETF. They simply buy all of the stocks, in the same proportions, as the portfolio of the ETF.
That basket is handed over to the ETF product manufacturer, in return for units in the ETF. The investor can then sell its ETF units on the secondary market or directly back to the ETF provider. Susan Darroch, head of global structured products for SSgA in the Asia Pacific region, says the acceptance of ETFs in Australia has been similar to in the US. SSgA launched its first ETF in Australia in 2001.
“It took time for them to take off,” she says.
“There was an education period. In Australia, the same thing happened. It took up to five years before the market – institutions and financial planners – became used to what an ETF is and how they can use it, and [before] they started using it.
“We had that education period, and I think you can see from the growth in volumes coming through the secondary market that Australians are embracing ETFs.”
Darroch says an index fund portfolio can be “a broad, diversified portfolio, and an ETF is an extremely efficient way to get a broad, diversified portfolio”.
“In one transaction you have exposure to 200 stocks on the Australian exchange,” she says.
“I think another thing that has come to the forefront in recent years is cost. It’s an extremely cheap way for non-institutional investors to get exposure to an index fund.”
An investment in SSgA’s SPDR S&P/ASX 200 Fund, for example, costs 28.6 basis points a year. ETFs that track US sharemarkets are cheaper still – the Vanguard US Total Market Shares ETF has an annual cost of 7 basis points a year, and the iShares S&P 500 ETF has a cost of 9 basis points a year.
Laidlaw points out that with investments into two Vanguard ETFs, investors can gain exposure to 93 per cent of the world’s sharemarkets, at a cost of 17 basis points a year.
