The best ETFs in a boom year

The growth of exchange-traded funds (ETFs) continues to be the biggest trend in asset management of recent decades.

This article originally appeared in the ASX September 2018 newsletter.

There has been phenomenal ETF market growth of 70% over the past two years in Australia. The growth of exchange-traded funds (ETFs) continues to be the biggest trend in asset management of recent decades. Their prominence has grown as the sector has matured and investors seek better diversification for their portfolios.

Stockspot’s annual Australian ETF Report is the largest analysis of the ETF landscape. It looks at the key trends within ETFs and gives investors an objective view to help them better understand and compare listed ETFs. This year 178 ETFs were analysed by looking at factors such as fees, performance, size and activity.

For readers unfamiliar with exchange traded funds the way to think about them is:

Rather than buying individual shares, ETFs provide direct exposure to a wide range of investments in their asset class like Australian shares, international shares, bonds or metals. An ETF invests small amounts in all the companies in an index, for instance the S&P ASX/300 index.

ETF fees are lower than typical ‘active’ funds. They have the benefits of transparency, immediate liquidity and potential tax advantages.

ETFs Globally

Over the past 15 years, over US$2 trillion moved out of active funds into index funds and ETFs. By 2020 it is projected that the global ETF market will reach US $10 trillion and by 2027 that it will be larger than the active managed fund market.

The use of ETFs in Australia has also grown at a phenomenal rate. The sector grew 70% from $23 billion in August 2016 to $39 billion in August 2018. Twenty-three new ETFs listed on the ASX over the last year, with a significant increase in global share ETFs and fixed income ETFs.

Diversification drives growth

Driving this popularity are individual investors, advisers and SMSF trustees. They’re attracted to ETFs’ low costs, transparency, diversification benefits and easy access via the ASX.

SMSFs and older Australians are turning to ETFs to earn better returns than cash or term deposits. ETFs offer lower risk and better diversification than only owning a few Australian shares.

The growing suite of fixed income ETFs is filling diversification gaps in many portfolios. For retirees and pre-retirees ETFs offer exposure to global shares and bonds, improving their overall diversification and lowering portfolio volatility.

Many young Australians are drawn to ETFs as their first investment experience, often via robo advisers or round up apps. The impact of popular business culture influencers such as Anthony Robbins and Tim Ferris, as well as Warren Buffett, all strong ETF advocates has helped raise their profile.

We believe children deserve the best start possible, which is why you can invest for your kids for free with Stockspot.

Best performing ETFs

In our 2018 ETF Report the best performing ETF of the year was the UBS IQ MSCI Asia APEX 50 Ethical ETF which returned 30.1%.

Asian focused ETFs performed strongly overall with 18.9% returns for the year, with four out of the top five ETFs by annual returns.

The BetaShares Crude Oil Index ETF Currency Hedged Synthetic (OOO) performed well with 22.9% aided by macro decisions to reduce oil supplies, Australian dollar weakness and ongoing political tensions.

The worst performers…

The BetaShares Australian Dividend Harvester Fund (HSVT) performed poorly. It invests in large ASX shares about to pay dividends while also selling futures contracts as a form of hedging. It significantly underperformed generating an annual loss of -16.2%.

ETF worst performers

Vanguard’s rise

Vanguard is popular with Australian investors because of the simplicity of their ETFs and broad market approach. The index mega fund’s rapid advance was propelled on multiple fronts in the past year.

Vanguard’s Australian Shares Index ETF (VAS) was by far the biggest winner in terms of FUM. It grew $888 million in the last financial year to $2.8 billion.

Vanguard also grew overall FUM by $3.2 billion (+45%), it now holds 28% of all Australian ETF FUM compared to iShares’ 29%. It is likely Vanguard will overtake iShares in 2019 as the leading ETF issuer in Australia.

Vanguard launched four new multi-asset ETFs and a new global bond ETF to expand its fixed income offerings.

The BlackRock owned iShares took $2.6 billion in new FUM (+33%). Its globally focused ETFs gained from strong share market returns overseas. It also launched two new fixed income ETFs in the past year.

ETF providers chart

Global ETF appetite

Global share market ETFs had an outstanding year in terms of returns and FUM increases. This category overtook Australian shares to become the largest sector attracting investor money.

The Australian share market still lags the US and Asia when it comes to technology company access. Many investors look to global ETFs to access superior diversification and to gain exposure to tech companies.

US shares were supported by strong growth from the tech sector. Betashares’ NASDAQ 100 ETF (NDQ) was the top performer with a return of 19.4%.

Also benefiting from exposure to tech giants like Tencent and Samsung, Asian shares had the second highest average returns of any region and grew FUM by 52.8% to $1 billion. iShares’ S&P Asia 50 ETF was the top performer in this category (as well as the second-best performer among all ETFs) returning 29.1%.

Emerging markets also had a stellar year with the top average return of 21.9% amongst all sub-groups. This grouping benefited from high growth in China, Brazil and Russia.

This sector has potential for higher growth but is a riskier investment due to their vulnerability to global macro-economic conditions. Since our Report was published, Emerging markets have given up some of their recent gains due to US/China trade tensions and a stronger U.S. Dollar.

Asset types chart

Australian broad market ETFs prospered despite low returns

The broad Australian share market ETFs such as Vanguard’s VAS ETF and SPDR’s STW ETF were popular with investors, who continue to gravitate towards large ETFs tracking well-known indices.

This is despite low average returns of 2.1% after fees (including a 4% – 5% dividend yield). It’s likely the popularity of these ETFs is from investors switching out of direct shares and underperforming actively managed funds.

The outperformance of small companies and negative returns of dividend and active strategies stand out as key trends. Australian banks have a large weighting in market-cap indices, their performance is the largest swing factor in determining if large cap beats small cap.

We road test 5 popular Australian share ETFs, comparing them across 6 factors in this blog.

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Smart beta ETFs and active ETMFs underperform

Smart beta is one of the latest trends in ETFs. Marketed as a new way to diversify and reduce risk. It aims to combine elements of passive index investing and active fund management to deliver the best of both worlds: transparency, broad diversification and market beating returns.

At their core, all smart beta ETFs take a bet on certain market factors being more important than others. Despite the large number of new active ETF listings (17 listed), few could match the return of their respective benchmarks or traditional market cap weighted ETFs.

This year Magellan’s Unhedged Global Equities fund would have beaten the Global 100 ETF if it weren’t for its high fees which brought net returns below the IOO ETF.

What ETFs to invest in

Stockspot believes when building their portfolio investors should look for ETFs that provide diversification across countries, sectors and asset classes. It’s important to keep your costs low and focus on asset allocation ensuring you have the right balance of growth and defensive assets for your investment goals.

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Founder and CEO

Chris has been vocal in calling out the industry 'Fat Cats' and is known for telling it as it is. He sits on two Advisory Committees for the industry regulator ASIC, and was previously a fund manager at UBS. He holds a Bachelor of Commerce (Accounting/Finance Co-op Scholarship) from UNSW.

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