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Ignore ETFs at your investing peril

Despite Exchange Traded Funds (ETFs) being labelled as one of the greatest innovations in global markets, their use and growth in the Australian market has been much slower than in other countries. Only now is this, in my opinion, game-changing instrument beginning to come to the attention of Australian investors.

As at December 2014, there were over 1400 ETFs available in the United States, with just short of $US2 trillion in net assets. At this time, 4% of US households held ETFs. Turnover in the ETF market in the United States has doubled in the last 5 years and is now in excess of $US1 trillion per month. Interest in ETFs in Canada, an economy only a fifth larger than in Australia, is also much greater than Australia. There are over 350 ETFs available in the Canadian market with assets totalling $US65 billion and a monthly turnover on the Toronto Stock Exchange of around $US120 billion.

In comparison, there are only 95 ETFs listed on the ASX, most of them with low turnover, with assets totalling $US18 billion and an estimated monthly turnover of around $US56 billion. ETF trading accounts for less than 1% of trading activity in Australia, compared with in excess of 10% in the US.

As mentioned in my previous posts on ETFs, there are numerous benefits that investing with ETFs has over active managed funds. These include:-

  1. Lower fees and costs than managed funds
  2. Trading flexibility
  3. Transparency of methodology and holdings
  4. Diversification and volatility reduction
  5. Flexible asset allocation
  6. Ability to invest in ETFs from your existing broking platform

And the most important benefit is that the ASX200 index ETF outperforms 75% of active managed funds over a five year period* and active managed Super Funds, including those vocal industry Super Funds that are always issuing press releases and advertising on our TV screens about their outperformance.

And as the term of comparing performance increases past five years the probability of any active managed funds matching, let alone beating, an index ETF gets lower and lower.

So, why are ETFs NOT growing in the Australian market as quickly as they are in other countries? It should be a no brainer for SMSFs that take a long term view to be using index ETFs as a core part of their investing strategies.

There are a number of reasons for this, mostly associated with a brigade of anti-ETF protagonists who stand to be hit in the hip pocket when, not if, ETFs gain momentum in Australia.

There are, of course, no upfront commissions or trailing fees paid to financial planners, brokers or advisers who operate on fees on FuM when investing in ETFs. Naturally, if this brigade can’t get a slice of the pie, they have no incentive to be part of the ETF distribution network to encourage investors and SMSF’s to use ETFs, and continue to be sales people for the use of active managed funds from whom they will receive a financial benefit.

Industry Super funds continue to trumpet negative press about SMSFs in ongoing attempts to stem the outflow of funds to SMSFs. It is obviously in the industry Super Funds best interest to continue to sow these negative stories otherwise their fee pile gets smaller.

Any accountant that has an attached financial planning business that operates on fees under FuM rather than effort based fees will guide you away from ETFs towards trailing fees based funds.

Many accountants who don’t have an aligned financial planning business have only a vague knowledge of ETFs and continue to stick to their old line about managed funds to mum and dad investors and SMSFs.

The financial press are still heavily biased towards managed funds, as they too have only a limited knowledge of ETFs. Very few understand the benefits of using ETFs although there is more and more mainstream press starting to write articles about ETFs.

Nearly all financial journalists still turn to the managed funds managers for comments to be included in articles. It is their old network of companies that do paid advertising that they rely on, none of whom will mention that menacing ETF acronym for fear of their clients wanting to find out more about them.

And lastly, to keep their costs to a minimum, ETF providers themselves do very little to no promotion or advertising about their products in mainstream press. And hence they don’t get the due attention from financial journalists.

The flip side to all these negatives is that those of us that are aware of the benefits of ETFs and of their use within SMSFs are well and truly ahead of the game. There is no doubt that the use of ETFs in Australia will grow – in both the number of ETFs available and turnover on the ASX – just as it is doing in the rest of the world.

The benefits of using ETFs that we continually discuss make them a great instrument for active investors and SMSFs. One day nearly all everyday investors will invest this way.

* Although I have done this research many times over the years to demonstrate this, this particular comment is actually based on research by S&P Dow Jones Indices SPIVA Scorecard.

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