Trends in ETF investments

4 min read

As with most other markets where they are available, exchange-traded funds (ETFs) reported strong growth in Australia last year.

An ETF is an investment fund that holds a basket of securities – such as shares or bonds that tracks a specified index – and is itself a listed share, traded on a stock exchange. Read more in this article.

At the end of December, the Australian Securities Exchange (ASX) hosted 175 ETFs, with a total market capitalisation of $35.7 billion. The capitalisation of the Australian ETF sector grew by 39.3% in 2017.

According to data from the Reserve Bank of Australia, there was around 80% growth in assets under management for exchange traded products in the four years to the end of 2016, with the total value reaching $5 trillion.

Around the world, ETFs (which are also known as exchange-traded products, ETPs) have become a larger industry than hedge funds. Growth in this form of ETF has outpaced growth in the traditional hedge fund industry since the global financial crisis in 2008: ETF assets surpassed hedge fund assets in June 2015.

Equity ETFs dominate the Australian landscape. The largest ETF category by market capitalisation on the ASX is global equities, at 41.6% with Australian equities accounting for 36.2% of the total EFT market.

In 2017, the global equity category, traded by local exchanges grew by $4.4 billion, or 42.7%. In comparison, the Australian equity category swelled by $2.9 billion, or 28.9%.

These figures reflect the most common use of ETFs among Australian investors, which is to gain diversification to different asset classes: in this case, overseas shares. This is particularly important for Australian investors, given the highly concentrated Australian share market – both in terms of being overly dominated by large companies, and in terms of the inferior spread of industries listed on the ASX. The fact that the Australian stock exchange index has underperformed global shares benchmarks since 2009 makes it an even more pressing issue for investors.

Part of the explanation for the huge performance gap between Australian and global shares is that the ASX has a very small technology sector: Australian technology companies contribute about 1.7% to the S&P/ASX 200 index's weighting, compared to the 27% weight that the technology sector has in the S&P 500’s value. The FAANG stocks (Facebook, Amazon, Apple, Netflix and Google parent Alphabet) account for 11% of the S&P 500 index on their own. Australian investors find it very difficult to gain exposure to the profound changes that technology is bringing: one way they can tap into this, is by holding large-cap US technology stocks. US-index equity ETFs are an option to give them this exposure – as are global-index equity ETFs, in which the US markets have a heavy weighting.

ETF performance on the ASX

In the ASX ETF universe, global shares products have significantly beaten those based on domestic shares. For example, according to the ASX, the best five performers (total return) over the five years to the end of 2017 were all global equities ETFs:

  • iShares S&P Small-Cap ETF (IJR): 22.95% p.a.
  • iShares S&P 500 ETF (IVV): 22.7% p.a.
  • Vanguard US Total Market Shares Index ETF (VTS): 22.58% p.a.
  • iShares S&P Midcap ETF (IJH): 22.18% p.a.
  • iShares S&P Global Healthcare ETF (IXJ): 20.55% p.a.

In contrast, the best-performing Australian equities ETFs over the last five years have been:

  • SPDR S&P/ASX 200 Financials ex A-REITs Fund (OZF): 11.32% p.a.
  • BetaShares S&P/ASX 200 Financials Sector ETF (QFN): 11.31% p.a.
  • Russell High Dividend Australian Shares ETF (RDV): 10.29% p.a.
  • SPDR S&P/ASX 200 ETF (STW): 9.90% p.a.
  • Vanguard Australian Shares Index ETF (VAS): 9.88% p.a.

Inflows reflect this. According to ETF provider BetaShares1, the Top 5 category inflows in the Australian ETF market in 2017 were:

International equities - $3.22 billion
Australian equities - $2.64 billion
Fixed income - $1.14 billion
Cash - $388.5 million
Australian listed property - $230 million

Currency ETFs were the only category to experience a net outflow for the year.

Although equities products dominated inflows, BetaShares says the fixed income category continued to grow strongly, taking in about $400 million more than in 2016. The provider says fixed income is an area where it expects product development to occur in a meaningful way in 2018.

Fixed-income/cash ETFs have grown from just $93.25 million in June 2012 to $3.96 billion in market value at the end of 2017. This category demonstrates, even more than global equities, how if you give Australian investors the means to diversify their portfolios simply and cheaply, in a listed product, they will take it.

Australian retail investment portfolios have traditionally shown a much lower weighting to fixed interest than those of northern hemisphere investors. Partly this was because many government, semi-government and corporate bonds were difficult to buy, because of high minimum-investment amounts, and partly there have been strong biases to shares and residential property among Australian investors.

ETFs focusing on fixed interest

But over the last few years, ETF providers have started to offer Australian investors diversification across the entire fixed-income spectrum, from cash to corporate bonds, offering them the chance to earn enhanced returns for some of the areas they must hold – such as cash – and exposure to different sectors, to allow a more tailored, diversified portfolio. More recently, ETF issuers have sliced the Australian market into even more targeted exposures, such as emerging market sovereign (government) bonds, corporate bonds, high-yield (non-investment-grade) bonds, floating-rate bonds and senior floating-rate bonds.

Another interesting trend in the ETF market, according to BetaShares, is that the ease of use, simplicity and cheapness of the vehicle compared to other managed funds is attracting millennial investors in particular. The provider cites figures from online broker CommSec, saying that millennials were responsible for 25% of all ETF trades in 2017. BetaShares believes that these younger investors like the diversification benefits of ETFs, which make them a great way to get started investing in the share market, but are also attracted by the way that ETF issuers have packaged themes and companies in which they can invest in a way that reflects their values – for example, in global sustainability leaders, or in stocks involved in cyber-security.

Along with the substantial growth in the scale and breadth for the ETF sector, including the stellar returns reported last year, we need to be reminded, there are risks like any other investment.  

Examples of these risks include Market Risk (share market falls), Concentration Risk (buying an ETF in a specific ‘narrow’ sector that may be subject to high levels of volatility), and Liquidity Risk – like any other form of investing, if a significant market fall occurs, there may be restrictions imposed on the timing and trading of redemptions.

With more and more ETF’s coming to market over 2018, we expect growth in this sector to further increase, with their usage to become more accepted as a bona-fide way of building and complementing a well-diversified investment portfolio.  

Note: Sources for figures are from Bloomberg, unless otherwise specified.

1. BetaShares Australian ETF Review – 2017 in Review

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Information current as at 8 February 2018. This document has been created by Westpac Financial Services Limited (ABN 20 000 241 127, AFSL 233716). Past performance is not a reliable indicator of future performance. This article provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. This information does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness, having regard to your personal objectives, financial situation and needs having regard to these factors before acting on it. This article may contain material provided by third parties derived from sources believed to be accurate at its issue date. While such material is published with necessary permission, no company in the Westpac Group accepts any responsibility for the accuracy or completeness of, or endorses any such material. Except where contrary to law, we intend by this notice to exclude liability for this material. Westpac Financial Services Limited and some of its related entities may have invested in the past, currently or in the future, in some of the ETFs referred to in this document.  ©Westpac Financial Services Ltd 2018