SMSFundamentals: A New Phase For Exchange-Traded Funds

SMSFundamentals | Oct 13 2017

SMSFundamentals is an ongoing feature series dedicated to providing SMSF trustees with valuable news, investment ideas and services, in line with SMSF requirements and obligations.

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A New Phase For Exchange-Traded Funds

SMSF interest is growing in the latest incarnation of exchange-traded products -- active ETFs.

By Greg Peel

Exchange-traded funds (ETF) were first listed on the ASX in 2001. The first ETFs allowed investors to passively trade the Australian stock market by investing in the ASX200 as easily as investing in an individual stock. The ETF sponsor would undertake necessary portfolio rebalancing and market capitalisation adjustments periodically, and the investor need only buy one instrument instead of two hundred to track the “market” return.

ETFs are traded in real time in market hours and the ETF sponsor guarantees a constant buy-sell price spread.

Further ETFs followed offering different index benchmarks, such as sector-specific, allowing an investor to just buy, for example, “the banks” or “the big miners” as a single instrument, and others expended into offshore offerings, for example the S&P500, with currency adjustments taken care of by the sponsor.

A second phase of EFT listing offered targeted investment strategies, such as portfolios of “value” or “growth” stocks, for example, or high-yield stocks. ETFs also expanded to include fixed income and commodities.

It took a while for ETFs to gain any traction in Australia, but from 2004 the growth spurt began. Self-managed super funds were introduced by the government back in the nineties, but similarly only started to take off around 2004, when the local market began to recover from the “mild recession” that wasn’t technically a recession at all. Super fund investors became outraged at the fees being extracted by the large, well known fund managers, and the SMSF army quickly grew.

It is of no surprise ETF growth corresponded with the growth of SMSFs.

As of last month, there were 216 different ETFs listed on the ASX, representing a total market capitalisation of $32bn – a compound annual growth rate of 30% since 2004.

ETFs 3.0

ETF listings are now entering a third phase. Previously, ETFs offered only “passive” investing – buying “the index” for example rather than trying to pick a portfolio of outperforming stocks. Strategic ETFs such as high-yield were also passive in the sense the sponsor selected and published its chosen portfolio and stuck with it. But the latest ETFs are “active”.

Anyone can “actively” invest by putting together one’s own portfolio or investing money with an active fund manager. In the latter case the investor simply trusts the fund manager to outperform “the market” or some other benchmark. But typically, fund managers only offer periodic windows of opportunity to redeem one’s funds, removing the possibility of “getting out quick”, or even getting in quick.

Enter the active ETF. Said fund managers can now list their active portfolios in ETF form, allowing investors to trade such funds as easily as trading shares. The difference between passive and active ETFs is the portfolio of passive ETFs is transparent and of active ETFs is not.

Publishing an active portfolio is effectively giving away one’s intellectual property. The portfolio make-up of an active ETF does have to be published, but only quarterly, and with a lag of two months. This means an investor in an active ETF is not investing on the basis of a particular portfolio, as the fund manager can change that at any time, but rather investing in the particular fund manager’s capabilities.

As with passive ETFs, real time pricing (net asset value) is available and a buy-sell spread is constantly being set, in this case by the fund manager. That fund manager will set the buy-sell spread depending on the balance of buyers and sellers of the ETF in the market at any time, but investors can compare available pricing with the constantly reset net asset value price.

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