Record year for ETFs as market shakes off pandemic
The Australian exchange-traded product industry has jumped by almost 30pc to a record $73.6bn, writes Van Eck’s Arian Neiron.
Mentioned: VanEck Investments Limited (ESPO), VanEck ETF Trust (GDX), Vaneck Msci International Quality Etf (QUAL)
It has been an incredible year for flows into Australian exchange traded products (ETPs) despite the COVID-19 pandemic and market volatility. The market could surge to over $100 billion in size in 2021 as more money flows into the sector away from unlisted managed funds as investors realise the potential liquidity and trading benefits ETPs offer.
Over the 12 months to 30 November 2020, the Australian ETP industry jumped in size by 29 per cent to a record $73.61 billion. It has been an especially strong end to the year, with US share markets striking record highs and ASX ETP net flows for October hitting a fresh high of $2.29 billion, up from a record $2.10 billion in September and a jump from $1.24 billion a year earlier.
Several factors have fed the record level of inflows. Many investors have turned to Australian equity income ETPs to build their portfolios after the March 2020 sell-off. Others have sought international equity exchange traded funds (ETFs) primarily for exposure to the tech heavy US share market as stocks—briefly—traded at cheaper prices. ETFs make up around 90 per cent of the Australian ETP market.
All of this drove record net flows into the ETP market over the year to 31 October of $15.43 billion, well ahead of 2019 net flows over the same period of $10.07 billion. Net flows into Australian equity market ETPs struck $5.58 billion over the year to 31 October, compared to $4.84 billion into international equity ETPs. Investors directed more money into Australian sustainable ETFs, with flows totaling $426.9 million, as assets under management (AUM) topped $1 billion in October, up 31 per cent from a year earlier.
Another sector that has soared due to the global recession and unprecedented central bank intervention has been gold and gold miner ETPs, with AUM rising to $1.47 billion, up 123 per cent from a year earlier. The VanEck Vectors Gold Miners ETF (GDX), the world’s largest and most traded gold miners ETF, has been a beneficiary of increased demand from investors turning to gold as a store of value and hedge against economic uncertainty.
Also popular this year have been fixed income ETFs, as interest rates fell to historic lows as central banks worldwide undertook quantitative easing to keep their economies afloat during the COVID-19 pandemic. Investors poured $1.71 billion into fixed income ETPs. AUM for Australian fixed income ETPs rose 29 per cent to $7.75 billion, while AUM for international fixed income ETPs jumped 86 per cent to $1.95 billion. This highlights an important point – ETPs are being used by investors not only to grow their exposure to growth assets such as shares, but also to build the defensive and income allocations of their portfolios as interest rates stay lower for longer.
More innovation products on offer
With an expanding diversity of assets being offered by ETPs, we believe even more funds will flow into the ETP market in 2021, which could take it to a market capitalisation of over $100 billion. ETPs offer diversification—in assets, sectors, and geographies through a single ASX trade. Their appeal is long lasting and growing as they open up previously inaccessible asset classes.
The ETP market is characterised by innovation in products. Investors can now, for example:
- Invest in the video gaming and eSports industry;
- Invest in global healthcare companies offering the best potential for growth at a reasonable price; and
- Invest in relatively high-yielding emerging market bonds.
In an Australian first, VanEck launched a VanEck Vectors Video Gaming and eSports ETF (ASX: ESPO), which is the only ASX ETF focused on investing in large video gaming and eSports companies globally. This ETF allows investors to tap into the mega growth trend of technology but diversify away from the FAANGS. Retail interest has been strong as investors can now back the companies producing the games such as Fortnite that many of them play.
Flows to smart beta still growing
As the industry has grown, the range of ETPs has increased from simple market capitalisation index-tracking ETFs to more complex managed funds, including smart beta ETFs and so-called “active ETFs”, which allow investors to access the capabilities of active investment managers on ASX. Active ETFs do not track an index and are not required to publish their full holdings at any time. By contrast, most pure (not “active”) ETFs track an index, and provide full transparency of their holdings on a daily basis. Smart beta ETFs track non-market capitalisation weighted indexes designed with investment outcomes in mind that can include active strategy approaches like “factors’’. Smart beta ETFs thereby combine the best of active and passive investing, with the potential for outperformance while being rules-based and cost efficient.
For example, the VanEck Vectors MSCI World ex Australia Quality ETF (QUAL), invests in around 300 quality companies as determined by MSCI based on three easily identifiable financial characteristics that enable companies to better withstand a downturn: high return on equity (ROE); stable year-on-year earnings growth; and low financial leverage.
Reflecting their appeal, flows to smart beta ETFs were strong this year, totalling $2.58 billion over the year to 31 October 2020, accounting for around 17 per cent of all ETP inflows. Smart beta FUM totaled $11 billion as at October 31, up 31 per cent from a year earlier. Smart beta market share is likely to continue to grow in 2021 as many active managers faced struggle with underperformance and pressure to justify their high fees.
VanEck's fifth annual smart beta survey reveals the majority of adviser respondents, or 73 per cent, increased their use of ETFs in the last year. The main drivers of this move to ETFs has been the desire to reduce portfolio costs, while smart beta ETFs are being sought by investors and advisers who are not impressed with the broad-based underperformance by active fund managers.
Research from S&P Dow Jones Indices, the SPIVA® Australia Scorecard has found that during the first half of 2020, the majority of actively managed funds in all categories (apart from Australian real estate investment trusts, or A-REITs) suffered worse drawdowns versus their respective benchmark indices. This Scorecard captures the COVID-19 volatility in March, highlighting that most active managers did not even match market returns, let alone outperform. This is a trend evident over the longer term too.
Given intense competition in the investment management industry and a demand for better investment outcomes, only those active managers who demonstrate identifiable and persistent outperformance will prevail. The difficultly for investors is finding those rare active managers that consistently outperform. The next year will likely bring further momentum in that move to smart beta ETFs and the broader ETP market in a world of ultra-low interest rates where investors are demanding their money work harder to create wealth.