“Gold has been recognised as a key component of a balanced portfolio – 2 to 5 per cent held in gold reduces risk,” he says.
“When the market was rising, virtually anyone could pick a stock, get a 10 to 15 per cent gain and look like a genius. When things became ropey, that’s when it sorted the men out from the boys,” Phelan says.
“ETFs won’t appeal to advisers who base their fee structure on trail commissions. But pressure from investors for fee-for-service advice will make ETFs more appealing to advisers going forward.”
A director of iShares, Tom Keenan, says that ETFs have a variety of applications; they are able to be used for strategic asset allocation for long-term investing or more tactical investing in the short term to suit the individual’s risk profile.
“Strategically, ETFs can be used to replicate benchmarks for global equity investing or the ASX,” he says.
“Advisers can create core portfolios and use ETFs to tilt the portfolio, with allocations in the US, emerging markets or Asia.”
Keenan adds that tactically, ETFs can be used the same way as any other equity; an individual or adviser might have an opinion on a particular stock, hold for a time and then sell. As an example, he says if they had an opinion about China, they could make a tactical call on emerging markets via an ETF.
Chris Schween, a director of Asset Builder, a small boutique specialist advisory firm, has been in business for 25 years and is now a passionate advocate of ETFs. He began using them for his clients two years ago and says since that time, his relationships with his clients have improved out of sight.
“ETFs have some major benefits over actively managed funds – they’re transparent, they’re tax-efficient, they allow for strategic asset allocation, they have clear returns and there’s an ease of management,” Schween says.
“ETFs provide effective indexing without getting too clever. I believe an index will always beat managed funds in terms of performance.
“You are in and out on the day you want to be. ETFs are a pure and straightforward investment – easy to monitor and nothing hidden. You can see exactly what stocks are underlying an ETF.”
Schween believes ETF clients are far more proactive than traditional managed fund clients. He says ETF structures are becoming a more common element in self-managed super funds (SMSFs) and are ideal for use under separately managed account (SMA) structures or individually managed account (IMA) structures and the like. And Schween points out the key benefit of ETFs should not be underestimated – their tax effectiveness.
The ETFMate.com.au website says most traditional trusts, and especially active trusts, have an average turnover of up to 70 per cent. Such a high turnover results in a high level of realised capital gains, which are distributed to their investors, who then have to report them on their tax returns. Broad index ETF products have a much lower turnover, like State Street’s SPDR 200 ETF, which has a 5 to 8 per cent rate of turnover. While with ETFs all dividends and franking credits are passed on to investors, few if any capital gains are released.
The key difference is that an ETF does not sell stock if there are redemptions – individuals just sell on the ASX to other investors, so there is no selling of shares by the ETF. Schween says that over the years, he’s seen many retirees invested in actively managed funds who haven’t paid tax in years suddenly presented with large capital gains tax bills after fund managers have distributed high capital gains, seemingly without any regard to the possible tax consequences for investors.
“I had an 80-year-old client forced to take $50,000 from a portfolio which had already crashed by 30 per cent, just to pay a tax bill as a result of capital gains from a managed fund,” Schween says.
“Conversely, with ETFs we can take a passive approach with our clients over the long term and have them liable for little or no capital gains tax.”
As to the application of ETFs, Schween is in agreement that it’s important to take a balanced approach and consider the individual client’s risk profile. He recommends investing in a mix of Australian and global ETFs with a passive approach, reviewing the portfolio every three to six months and tweaking the asset allocation where required.
“Ninety-five per cent of investment success is all based on asset allocation and a disciplined approach to maintain the allocation through good and bad times. ETFs are a great way to do that,” he says.
Nigel Baker is principal of WHK Horwath Wealth Management, one of 20 businesses that form one of Australia’s largest independent accounting groups, with more than $9 billion under advice. His business is also using ETF products, primarily as part of a passive approach, mainly for the core holding of large companies. He believes there will be even more growth in ETFs.
“Although ETFs are relatively new to our market, they’re huge overseas and the trend will continue here,” Baker says.
He sees the ability to access any market, as well as low cost and tax effectiveness, as being key benefits of ETFs – although he cautions that the lack of hedging on international ETFs should be considered. He also recommends advisers be cautious of liquidity and talk to the ETF operator about risk.
