ETFs have long been something of a buzzword, but they remain surprisingly under-utilised in portfolios. Only 7 per cent of Australians own ETF assets according to a survey by comparison site Finder, and they are most popular with Generation Y and least popular with Baby Boomers.
Often conflated with passive investing and index funds, they can be used to give access to almost any factor, theme, sector or asset class in the market, and are increasingly used as building blocks in actively-managed portfolios.
But ETF funds under management in Australia ended at $130 billion in December 2022, which was slightly less than the $134 billion in December 2021, according to ETF Tracker. While 2022 inflows did drop compared to 2021, they were still positive, and poor returns were key to driving down FUM.
Sydney-based Wheatley Wealth Management principal Alexis Wheatley tells Professional Planner she previously used passive funds mostly for Australian bonds, although has stopped doing this lately as interest rates on simple savings accounts became more attractive.
But she has looked at ETFs for thematic exposures such gold or even very specific areas like electric vehicles. For younger clients with a greater risk appetite there are several leveraged ETFs from credible providers that seem attractive, she says, owing to fund managers being able to access relatively cheap debt.
“I’m very careful with the ones that I pick, and don’t want to add to the risk in the portfolio unnecessarily,” Wheatley says, noting she would likely be using them more as options in the market increase.
In the US, equity ETFs make up 12.7 per cent of equity assets, totaling $5.4 trillion of equity ETFs. But ETFs remain a fraction of the total global financial market in both equities and fixed income, ranging from 4.1 per cent to 12.7 per cent of equities and 0.3 per cent to 2.7 per cent of fixed income assets by region, according to BlackRock-owned ETF provider iShares.
Lonsec CIO Lukasz de Pourbaix says cost is a fundamental driver of their take-up as investors become more discerning where they spend their fee budget.
A partial allocation to ETFs can allow investors to reduce their overall portfolio fee, while leaving part of their allocation for more active investments that reflect their view of the market.
“We are seeing more and more portfolios adopt a core satellite approach, where the core allocation will be, say, index-tracking ETFs, and around that they might have a few active funds to sectors and parts of the market where you can’t get access… via ETFs, for example long-short equities,” de Pourbaix says.
There are also parts of the market – such as small cap equities – where investors typically believe an active approach can add more value, he says.
But with a growing ecosystem of ETFs addressing specific exposures, some investors are also using ETFs to gain exposure to a certain factor in the market at low cost. ETFs also provide a way to benchmark managers, he says, for example by ensuring a value manager can truly generate value when compared to factor ETFs.
With rising inflation and interest rates, and rising bond yields, government bond ETFs are seeing greater allocations than in previous years, he said. So are cash-style ETFs, and thematic ETFs which give exposure to a certain specific theme.
There is also ongoing growth in active ETFs, where a manager or team make ongoing decisions on the underlying portfolio allocation, using ETFs as “building blocks” to tap into themes or sectors.
As with much of investing, understanding the underlying details of an ETF is critical. Does the fund own the actual underlying assets, or rely on a proxy? What is the depth of the market you are in? Who are the market makers and is the process transparent? And with some parts of the fixed income market difficult to price daily, how reliable is the pricing?
It is critical to understand the internal rules, particularly for factor ETFs, de Pourbaix says.
“Some are very rules based, and it does mean some of those exposures will have added risks as well,” he says.
“If it’s an asset that is less mainstream, you need to have a good understanding of how it works.”
