Investors flock to ETFs which have transformed investing
If you are looking for one of the biggest changes in how global share markets work over the past couple of decades, the humble index tracking Exchange Traded Fund (ETF) would be hard to beat.
Just look at some of the figures for Australia and the significance of this shift is extraordinary and our market is very much playing catch up to other places around the world on this trend.
In the past year in Australia, the ASX’s ETF market grew by an astonishing 36% to reach $200 billion by the end of June – even more if you include the Cboe exchange.
That compares to a decade earlier when ETFs represented less than $10 billion, so the growth has been phenomenal.
Lack of commissions an early handbrake
I have a strong memory of having lunch with one of the early Australian ETF innovators who was extremely discouraged by the lack of success in interesting financial advisers in recommending ETFs to their clients.
“I keep explaining the benefits of low costs and diversification but all they want to know is how much commission they would get from recommending them,’’ the discouraged ETF promoter lamented.
Of course, we all know what happened next – the financial planning industry went from a massive boom to bust, particularly after the banking Royal Commission, a younger generation seized the opportunity to invest directly in US technology companies they knew a lot about through ETFs without using intermediaries like brokers or financial planners and hefty, non-transparent trailing and other commissions went the way of the dinosaurs.
It is easy to see these as irresistible trends now with the benefit of hindsight but in those early days of ETFs when active management was seen as the only smart way to invest, the ETF boom was far from a foregone conclusion.
It was offshore investment that was behind much of the 36% boom in ETFs in the past year and it is far from a buy and hold situation too, with ETF transaction volumes also up 50%.
International equities drag in the cash
International equities led the gains at $29 billion while Australian equities also impressed, up $15 billion.
Fixed interest ETFs ran a distant third at $5.2 billion but again, this was a part of the market that was really difficult to invest in directly 15 years ago.
With the Australian share market only representing around 2% of global equities, such international diversification is a welcome trend away from the old home town bias, which has been led just as much by low-cost opportunities as it has been by an awareness of global opportunities.
It is hard to explain to today’s investors what it used to be like buying US stocks directly back in the bad old days, setting up special accounts and filling out tax forms with your local broker who dealt with a broker in the US and paying eye-watering brokerage to buy a US stock.
As for trading US stocks, that was slow, expensive and cumbersome.
As for government bonds – either local or offshore – that entire asset class was difficult to invest in without using intermediaries such as fund managers.
With no such problems now with many listed ETFs with tiny investment costs, Australian investors could and did easily jump on board the US share market rally this year.
Active ETFs the next frontier
The latest trend in ETFs is actively managed funds, with more than 65% of new products in Australia actively managed, according to figures from Vanguard.
Some of those actively managed or sectoral ETFs were also some of the best performing over the past year, including those based on cryptocurrencies such as Bitcoin and Ethereum and also those exposed to US technology shares and artificial intelligence.
As of last year, 1.5 million Australians hold at least one ETF and given the rapid growth trends it would not be a surprise to see that number rise a lot more over time.
Despite the rapid growth in the Australian ETF market we are still well behind the trend in the US market which has an incredible $12 trillion invested in 3,108 different ETFs.
The total net assets of these US ETFs accounted for an amazing 24% of assets managed by investment companies, so Australia still has some catching up to do.