Are ETFs a danger to investors?
Having now topped $4 trillion globally, exchange-traded funds have drawn criticism from some quarters as a dangerous bubble, but is this justified?
Having now topped $4 trillion globally, exchange-traded funds have drawn criticism from some quarters as a dangerous bubble, but is this justified?
Morningstar director of manager research, Tim Murphy, sat down with two senior figures from the Australian ETF space at the Morningstar Individual Investor Conference earlier this month.
Murphy asked Jonathan Shead, head of portfolio strategists, Asia Pacific, State Street, to describe what ETFs are.
Shead used the analogy of a cardboard box that is filled with shares: "It's just a convenient way to trade a boxful of shares."
One of the structural features of an ETF he highlights is that the top of the "box" is open.
Being open-ended products, as distinct from managed funds, he says: "It's very easy to increase or reduce the size of the ETF just by taking shares in or pulling them out ... it can respond very easily to market demand."
"They're highly flexible, they can cope with very large flows, they're really liquid and easy to trade. In that respect, they are a little different to traditional managed funds or other listed products where the top of the box isn't open," Shead says.
Murphy also poses the question of whether ETFs are the next major risk facing investors, as has been suggested by some commentators and by sections of the active fund manager community.
"We have to do an eye-roll in unison here ... sometimes I think that because [the abbreviation] ETF has three letters, any financial product that has a three-letter acronym must be destined to become a bubble or to become unstable or something like that," Shead says.
He refers here to another investment product, the collateralised debt obligation (CDO), that was a central part of the GFC.
"But ETFs are really among the most robust products you could find, and are the least susceptible to being classified as a bubble," he says.
He compares them with the broader Australian equity market, saying that only if you believe the Australian share market is a bubble can you consider ETFs in the same way.
"ETF's don't have the liquidity issues that other parts of the listed market have," he says.
Indeed, the number one danger he identifies within ETFs is their ease of trading.
"With a managed fund, you get a [product disclosure statement] PDS; you have to flick through the PDS until you get to the perforated page, which you have to fill in and mail it back," Shead says.
"With an ETF, all you need is the ticker. And so, the risk in an ETF is that you see a ticker, you think you know what it is, and you trade it.
"I'd strongly encourage you to make sure you've got a basic understanding of what the ETF is doing ... the more nuanced the strategy, the more important it is to understand exactly what it's doing."
Co-panellist, Alex Vynokur, co-founder and managing director of BetaShares, draws a clear distinction between ETFs and another type of listed vehicle that is now seeing revived interest, the listed investment company (LIC).
"We get a lot of questions around this, and the key difference is that a LIC is a closed-ended investment vehicle. When there are more buyers than sellers, they will sell at a premium to fair value," he says.
"ETFs trade at or very near fair value ... so from an investors' perspective, you get transparency around not only what's under the bonnet, but you also get peace of mind of knowing that you can buy and sell throughout any trading day on the ASX at the fair price."
The panellists also discussed what Morningstar refers to as "strategic beta," often called "smart beta" by others in the financial industry--a sub-category that now has more than $2 billion invested in Australia alone.
"Historically, you've had the choice between investing in an index, or trusting an active manager to buy some combination of cheap stocks that are high quality and high growth, but now we can systematically get access to those through the ETF structure."
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Glenn Freeman is a senior editor at Morningstar.
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