ETFs going mainstream

The introduction of fixed income exchange-traded funds (ETFs) on the Australian Securities Exchange (ASX), announced on 10 January 2012, was an important development for the country’s investment market since it introduced a complex product into the mix and opened up an asset class suite that will subsequently create new portfolio construction opportunities.

BlackRock’s ETP Landscape Report revealed that globally, exchange-traded product (ETP) assets reached a new high of US$1.85 trillion at the end of September 2012. In Australia, ETP assets under management increased by 16 per cent, reaching $5.7 billion in September, according to the ASX.

While ETF providers agree there’s no question that the listed structure’s use by advisers will be a gradual evolution when it comes to comfort levels, the next stage of growth and expansion is already underway.

These new developments could potentially turn ETFs into a mainstream vehicle for clients who are embracing direct investing.

While it was independent advisers who originally took the lead, dealer groups are now using ETFs more, planning to offer ETF model portfolios to their own aligned advisers. This will be a trigger for more growth next year, as take-up begins to even out across the board.

iShares director Tom Keenan says continuing developments will push ETFs to become part of the mainstream investment landscape.

“ETFs are starting to become much more mainstream,” Mr Keenan tells ifa. “Part of that is that the number of advisers that are using them has increased markedly, the number of research houses that are providing research on ETFs has increased markedly, and the number of broking firms that provide research on ETFs has increased markedly.

“I’m so enthused about the future of the industry.”

What to expect next

State Street Global Advisors (SSgA) Australia’s director of ETFs, Amanda Skelly, says Australia is only in the early stages of growth.

“We haven’t really experienced what that looks like yet,” she says, adding that there could be multi-asset ETF opportunities in the future and considers them the next step at the product level.

“It’s starting to see some momentum in other markets. We don’t have them here yet as model portfolios are the preliminary step to that, but the end game is: I’m an investor, I want to buy one ETF that gives me multi-asset exposure.”

Skelly believes it will be a goal all providers work towards.

“It’s not going to be for everybody, as some investors want control and therefore will need to be able to use the underlying building blocks the way they want to,” she says, “but if we’re going to go more mainstream, the multi-asset, balanced kind of ETF is certainly somewhere we need to come to.”

Global macro investing has also been an emerging trend, as investors see more value offshore and realise the significance of diversification.

“What we’ve seen is a huge shift away from broad-based Australian equity ETFs into broad global ETFs,” Skelly says. “That’s the one that’s been the biggest winner here in this market, followed by an S&P500 ETF.

“Some investors are obviously taking a bet with the United States equity market, which has been a market that has been the most undervalued.”

Russell Investments ETF product specialist for Australia, Paula Boon, says that as a provider, the group is also eyeing global ETF opportunities.

“Our approach has always been to deliver innovative and tailored solutions that meet specific Australian investors’ needs so we are continuing to look for ETF opportunities, specifically with a focus on outcome-oriented solutions,” Boon says.

“One theme that has emerged is to offer a global solution, which would fit and complement the current suite of ETFs we have at the moment,” she says. “We’re still in the early stages of scoping out our opportunities, but it will definitely be in the global space.”

ETFs in MySuper

As part of the federal government’s Stronger Super reforms, MySuper products will replace all existing default funds by 1 July 2013. From 1 January 2014, employers will have to make contributions for employees who have not made a choice of fund to a fund that offers a MySuper product in order to satisfy superannuation guarantee requirements.

According to ETF Consulting director Tim Bradbury, the link between ETFs and MySuper should be a “no brainer” as a short to medium-term solution for investors.

“The superannuation industry potentially says that MySuper will be a cheap balanced fund, but it might not be as cheap as an ETF-type fund, which to my mind is lazy because that’s not really building a MySuper product,” Bradbury says.

“If you want to build the absolute, low-cost, flexible MySuper-type offering, ETFs are the best way to do it. You’ve got choice, you’ve got low-cost and tradability and then if you want to build ‘sexier’ versions of MySuper to offer to various parts of the market, you can put in some active funds or tactical asset allocation.

“So the whole MySuper idea lends itself to ETFs perfectly.”

But while, in a perfect world, MySuper and ETFs would be a perfect fit, it will still take someone to connect the two successfully to demonstrate the potential, Bradbury says.

“I suppose it will take someone to build an ETF-only portfolio [first],” he says.

SSgA’s Skelly agrees and says industry players are looking to use ETFs as a point of difference against their competitors for their MySuper solutions.

Several superannuation funds are looking to offer dynamically balanced funds using the popular structure, she says – although not all MySuper products will adopt ETFs; rather there would be mainly large players that would simply offer very low-cost options without ETFs.

“The role ETFs play in the MySuper space will largely depend on the size of the institution, but for those who aren’t yet at the scale of an Australian Super, for example, ETFs will provide a low-cost proposition for them,” she says.

“What they can do is access them at a lower cost for their MySuper option, but also by using ETFs, they can dynamically adjust their allocations, which is a way that they differentiate themselves away from their peers.

“They’ll be quite static options that you can’t differentiate from the others and then there will be the smaller players trying to differentiate themselves against the big players – they’re the ones who will widely adopt ETFs.”

Confusion and naming conventions

While ETFs are likely to continue to evolve, they face an obstacle with the regulator’s intention to apply strict naming conventions for all products in the Australian market.

Being able to interpret the differences between ETFs, ETPs, exchange-traded commodities (ETCs) and exchange-traded notes (ETNs) is vital both for advisers and especially for investors. ASIC’s approach may, however, be too austere and could cause confusion.

In June 2012, ASIC said it was managing the risk of investor confusion by ensuring that structured products were not called ETFs.

“They are required to be labelled as structured products so as to avoid investor confusion and so you know what you are buying. However, issuers often also use names such as ETNs, ETCs, exchange-traded international securities or trackers,” ASIC said at the time.

Vanguard Australia’s head of product and marketing, Robyn Laidlaw, says investment products should be clearly labelled to reflect the structure of a fund.

“However, it will be important for ASIC to ensure that categories and naming conventions don’t use too broad a brush to paint the wrong picture for investors, or use categorisation that can be misconstrued by investors who lack a sophisticated understanding of investment terms,” Laidlaw says.

“We believe that there needs to be consistency between how ETFs are labelled and managed funds are labelled because they are essentially the same product accessed via a different market.”

Advisers are already uncertain about the categorisation and differences between ETFs as they currently stand, thus the introduction of prescriptive and complicated categorisation is bound to cause confusion.

“Contrary to the Australian Stock Exchange and my view, the regulator’s view is that if you’re an ETF, you’re a passive index tracking vehicle and largely physically backed; if you’re not, you’re something else,” Bradbury says.

“So they want to call actively managed ETFs a ‘managed fund’.

“That gets complicated where you have an active ETF that’s repricing every few minutes with market makers and then AQUA 2 comes along and you have managed funds that don’t reprice intra-day – that’s really confusing.”

Bradbury predicts that the term ‘exchange-traded product’ (ETP) will be more frequently adopted, with ETFs – which are physical funds – sitting under ETP, followed by managed funds and structured products.

Efforts to educate continue

Despite information on ETFs and implementation tools being plentiful, there are still pockets of advisers who remain uninformed.

“They go through this process of getting themselves ready: they haven’t learnt or been taught how to do the trades, they do them, get a bad execution and then say that was a waste of time and effort and go back to what they were using before, which was managed funds et cetera,” Bradbury says.

“Advisers need to be in control of it and they should have a good experience, otherwise they’re not going to go back for a second time.”

The good news is that as the industry grows into new asset classes, so too do tools for advisers and investors, which were not previously available.

“There are some new tools coming out which will enable people to construct ETF model portfolios that can really roll up all the underlying holdings,” Skelly says.

“All of the ETF providers are looking to expand the level of education they provide and here at the SSgA’s SPDR shop, we’re looking at interactive tools, more than just the usual collateral.

“Self-directed investors like to be in control [of their investments and decisions] but they haven’t been able to do that with portfolio construction with ETFs because the tools haven’t been there. Giving people the tools to do it themselves is going to be a huge leap forward.”

iShare’s Keenan adds that once advisers start using ETFs, they rarely stop.

“Now that they’ve got fixed income allocations, they very quickly start thinking about how they can use the same type of vehicle to implement different asset classes,” he says.

“That process is underway and there’s an education process around not only fixed income ETFs but fixed income markets themselves and that’s a process that will gain momentum in the coming years.”

iShares will ensure the group fully understands advisers’ businesses and needs, says Keenan, since it is no longer acceptable to provide support that does not go beyond just the delivery of ETF products.

“If you don’t understand an adviser’s business and how they’re seeking to grow, then you can’t really understand what role ETFs can play in their portfolios so we see that as critical to the way we deliver solutions to our clients,” he says.