A recent report by PwC outlines the growth trajectory of the ETF market and the areas of focus for asset managers, including active ETFs, thematic ETFs, and ESG ETFs.
The report also acknowledges hurdles confronting the growth of the industry. The views expressed are based on the opinions of more than 70 ETF executives from all major markets in the world.
As a business, we cover the entire spectrum of investment products to provide our advisory clients with insights into the costs and asset exposures of these investments. The ETF sector is unquestionably poised for growth. According to the 2022 Betashares/Investment Trends ETF Report, ETF usage is projected to increase at a rate of six per cent per year, which differs significantly from the PwC forecast of doubling by 2027.
So, why the disparity?
In the realm of advised investments, the cost of advice has prompted many advisers to transition towards Separately Managed Accounts (SMA) or Managed Discretionary Accounts (MDA).
As of September 2022, the estimated assets under management (AUM) for these accounts totalled $164 billion, with most multi-asset portfolios being managed by ten different managers.
Due to the scale advantage for practices and the revenue considerations, SMAs and MDAs have emerged as preferred investment products over ETFs in Australia. However, ETFs have seen limited benefit from this trend, as some managers do incorporate ETFs in their managed portfolio solutions.
Fixed income ETF products have experienced significant growth globally because of aging demographics across developed markets. Locally, we have seen 19.6 per cent AUM growth in pension phase assets. ETFs do not directly provide solutions in this space whereas with rising rates, annuities are taking significant market share.
Recent volatility in the fixed income asset space has not helped either. Additionally, with the reset in interest rates the current structure of ETF fixed income products is not designed to manage all the fixed income risk and return factor exposures. Poor benchmark selection is an issue in this space and will act to constrain demand.
Thematic ETFs in Australia have experienced a slow evolution, with a total of 20 such ETFs currently available, of which nine are managed by Betashares. These ETFs primarily focus on the technology and ESG sectors in a passive manner.
Despite this, the global market for thematic ETFs has witnessed remarkable growth, with AUM increasing by 112 per cent. Additionally, active thematic strategies are also available. Thematic ETFs can serve as excellent satellite vehicles for advisers to incorporate into their investment strategies.
In other markets, portfolio construction has been facilitated using ETFs in off-platform structures, owing to advancements in technology, regulation, and market practices. This has made it easier to construct viable portfolios, especially when utilising custom or direct indexing solutions, and factor strategies among other approaches.
Australia’s ETF universe is still very much a passive investing environment while other markets have experienced significant growth in the active ETF space. In the US, 35 per cent of active fund flows were to active ETFs even though they only represent two per cent of all active products.
Active ETF options are starting to be rolled out. A major hurdle is the daily portfolio disclosure requirements for some active managers. The International Organisations of Securities Commissions has developed a “semi-transparent” disclosures approach, based around benchmarks to solve this issue and encourage transition from unlisted managed fund to ETF product structures.
Full disclosure of holdings is in the best interest of the investor and allows for open markets. Decisions like this should also look beyond manager concerns about showing positions to how lack of disclosure impacts the functionality of other products, such as SMAs.
Ongoing structural issues with the ETP market in Australia does not help the growth of the ETF product group, particularly the market-making structure, the relatively high implicit transaction costs and low liquidity being quantifiable examples off these structural issues.
The PwC report highlighted the issue of education. Education is lacking with most retail investors and a significant number of professional folks not really understanding these products sufficiently.
Many product providers do not help this by failing to clearly articulate the “value” of ETF products within a portfolio.
Overtime, greater use of ETFs within managed portfolios is guaranteed and will ensure continued growth in this product area.
Additionally, the emergence of factor strategies, direct indexing, increased ESG demands, portfolio optimisation needs and flexible retirement products, this product area will grow significantly in the near term.
Sustaining margins in products will become more of an issue, hence the need for better ETF market structure and cleaner regulation to facilitate lower-cost products for end users, as well as a suitable return to product providers.
