If there is a breakthrough financial product tailor made for the times we live in, it is the humble exchange traded fund or ETF.
While funds that track share market indices are quite old now, it is only in recent years that their popularity has soared.
The idea behind ETFs is simplicity itself – instead of actively choosing shares within an index such as the ASX 200, why not simply buy the entire index which includes the good, bad and ugly companies.
It is an approach that many studies have shown to be cheap and effective, giving investors very low costs of ownership, lower taxes and trading costs, instant diversification and low overall fees.
Active managers struggle to better the “passive” approach
While such an approach is defined as “passive”, it is important to note that the stocks you own and the proportion of the index they make up is constantly changing, so you are effectively pyramiding into shares that are performing well and exiting stocks that are falling.
It is for this reason that active fund managers who only buy some of the shares in the index in the hopes of outperforming fail so often, with fewer than 20% actually succeeding every year.
Given that an active approach almost always leads to higher fees and taxes and you can never tell which manager will be the one to beat the index in any particular year, it is little wonder that buying ETFs has become so popular.
High house prices pushing younger investors into the share market
Another tailwind for ETFs has been skyrocketing house prices, which have led to many millennials and other younger investors to put their savings in the share market instead.
The latest half year review of ETFs shows up this trend, with the industry steaming effortlessly past the $100 billion mark.
Indeed, it would not surprise if ETFs represented more than $130 billion by the end of 2021 – a far cry from the infancy of the industry when some financial advisors refused point blank to put any money with the asset class because there was no money in it for them.
Helped by fast share market growth which quickly inflated the amount invested, the first half of this calendar year has seen a 22% rise in the value of Australian ETFs to $115.7 billion – an all-time high and the fastest yearly growth in dollar terms ever seen.
Growth and new money both driving ETFs higher
While not all of the $20.6 billion rise in just six months was due to the flow of investor funds, just under half of that growth was due to inflows, which is still a considerable amount.
Net new money for the half year was $8.8 billion, up from $8.3 billion in the first half of 2020, according to BetaShares research.
While that is a 6% growth in dollar terms, it was still slower than the previous six months in the second half of 2020 which saw an impressive $14 billion flowing into ETFs as investors jumped on to the fast improving share market.
Whichever way you look at it, investment through ETFs is undergoing robust growth but the interesting thing is where this growth is coming from, with the traditional index fund still doing the bulk of the heavy lifting.
Scene is changing but big index funds still most popular
The past six months was a time in which a lot of actively managed or non-indexed funds hit the market, with all seven new ETF issuers being active managers and four funds converting into active ETFs.
Interestingly, we also saw the first listed investment company (LIC) change itself into an active ETF in the form of Monash Investors (ASX: MAAT).
We have also seen one of the large LIC’s in the form of Milton (ASX: MLT) set to merge with investment company Washington H. Soul Pattinson (ASX: SOL) to create a combination with a market capitalisation of $10.8 billion – making it a top 50 company.
One of the issues confronting LIC’s is that they sometimes trade at either a premium or a discount to their net tangible assets (NTA), both of which can be a problem.
If you are holding an LIC share that is trading at a 20% discount to NTA, it is difficult to sell out and leave that value behind, while buying into an LIC which is trading at a 20% premium to NTA is also a difficult proposition.
All of which is why BetaShares expects more LIC’s to convert to an ETF structure over time, particularly smaller LIC’s that are trading at significant discounts.
International equities the biggest winner
While there has been plenty of innovation in the ETF space, most of the actual cash inflows went to traditional passive index products.
The most successful of those was international equities, followed by Australian equities, fixed income, multi-asset and listed property.
With such a strong across the board performance, as you might expect outflows were minimal with cash products predominating.
Trading values were strong, with about $7 billion to $8 billion changing hands each month.
Demonstrating how high ETF returns can get, there was an impressive performance by the Crude Oil Futures ETF (ASX: OOO) which returned 50% for the half year, followed by Betashares Geared U.S. Shares Fund (ASX: GGUS) which produced a 34% return for the half year.