Low fees, lacklustre active returns among ETF demand drivers

Australia's exchange-traded-fund market is tipped to doubled over the next three years as more investors abandon managed funds and direct shares, says an online investment adviser. 

Stockspot predicts ETF assets in Australia will reach $100 billion by 2022, up from $45.8 today, as ETF demand is driven by "investor appetite for:

• low cost transparent products,
• increasing product innovation,
• a continual shift from active underperforming active funds into indexed products, and
• the growth of digital wealth managers adopting ETF based portfolios."

Morningstar associate director of manager research, Alex Prineas, says structural tailwinds – such as low cost, convenience, transparency, and regulation that favours open architecture – which may even become more important in the wake of the financial services Royal Commission - has benefited the market. 

Since 2014, the ETF market has grown at a compound annual growth rate of 34 per cent.

Australian ETF Assets Growth

Source: Stockspot, ASX using March data

Looking ahead, Stockspot report author Marc Jocum says several themes will play out in the ETF landscape including large, broad market ETFs continuing to dominate inflows, growth of bond ETFs, a rise in global sectors and strategies, and exchange traded managed funds (or active-ETFs).

"As active managers continue to try to remain relevant, many are launching ETF-like wrappers around their active funds in an attempt to gain visibility and potential inflows," he says.

BetaShares has now narrowly overtaken State Street as the third largest provider of ETFs in the Australian market behind Vanguard Investments Australia and iShares, with total net assets of $6.3 billion. 

Shots fired in fee war

The battle for market share reignited last month, when BlackRock Australia – which manages iShares ETFs – slashed the fee on its flagship product iShares Core S&P/ASX 200 ETF (ASX: IOZ) by almost 50 per cent to 0.09 per cent. 

Vanguard launched its own offensive a day later, lowering fees to 0.1 per cent across several of its funds and ETFs, including the Vanguard Australian Shares Index ETF (ASX: VAS).

The price cuts bring management fees for the two ETFs within striking distance of the newest competing product, the BetaShares Australia 200 ETF (ASX: A200), with an annual fee of 0.07 per cent.

The fee war is creating pressure across all local ETF providers, but particularly SPDR's S&P/ASX 200 ETF (ASX: STW), says Morningstar's Prineas. As the largest ETF on the market, it has $3.9 billion in funds under management and a 0.19 per cent management fee.

A race to the bottom

If the US experience is any guide, Australia's competitive landscape could be driven by fees.
The US ETF industry has ballooned to $3.4 trillion in assets, with the following three dominant firms dividing market share accordingly:

• BlackRock's iShares – 39 per cent
• Vanguard – 25 per cent and growing
• State Street – 16 per cent and shrinking

A decade earlier, iShares held 49 per cent, State Street 26 per cent and Vanguard less than 10 per cent.

Firms' relationship between US ETF fees and flows

Source: Morningstar Direct

Fees have been the main driver of this shift, says Morningstar's global director of passive strategies research, Ben Johnson – along with the quality of their respective ETF product line-ups and distribution networks.

"In this highly competitive space, especially in areas where fund companies offer ETFs based on the same or very similar indexes, the lowest-cost provider has generally been the most successful in attracting longer-term investors," Johnson says, in a joint report authored Morningstar data journalist Gabrielle DiBenedetto and editor Tom Lauricella.

"Vanguard's low-cost profile has particularly forced a fee-war for market share."

Changing advice model post-royal commission

Australia's ETF market continues to trail behind the rest of the world in terms of size, product development and concentration, Stockspots report finds. 

While there are vast differences in the addressable market sizes and respective populations, Australia still has a comparatively small number of products. The global ETF market currently stands at US$5.4 trillion across 7,720 products, of which US ETFs comprise 69 per cent.

Australia accounts for around 0.6 per cent of the global ETF industry, with $45.8 billion allocated across just 192 products. Australia's total assets under management across all products now sits at more than $1.7 trillion.

ETF Market share by country

Jocum says part of the reason for this is the concentration of investment advice among the big four banks and large wealth management firms, and their inherent vertical integration models.

"Ask your average American investor about ETFs or index funds and they’ll be able to tell you what they are and which one they’re invested in. Sadly, this is not the case in Australia," he says.

"There continues to be a large focus on using active funds and buying stocks in order to 'beat' the market."

He expects the playing field will be levelled for ETFs once adviser trail commissions are banished entirely.

Factors take centre stage

Local product offerings continue to evolve with 24 new ETFs launched over the past year.

Seventeen of these were Global Share ETFs, some with tactical tilts and thematics – including the BetaShares Asia Technology Tigers ETF (ASIA) and the VanEck China New Economy ETF (CNEW).

Seven of the 24 new ETFs launched were those run by active strategies not tracking a particular index/benchmark, as fund managers like Fidelity, Legg Mason and Antipodes threw their hat into the ring. 

Stockspot's Jocum notes Vanguard and BetaShares have indicated their enthusiasm for offering smart beta ETFs as an avenue for investors to try and beat traditional benchmarks – BetaShares Global Quality Leaders ETF (QLTY) and Vanguard Global Minimum Volatility Active ETF (Managed Fund) (VMIN) as two examples.

Morningstar's Prineas warns investors need to be even more discerning as the number of passive products rises: "Not all ETPs offer benefits in equal measure."