Why financial advisers need to learn to love ETFs
Australian financial advisers haven’t exactly embraced ETFs, despite the sector growing in popularity each year. Janine Mace finds adviser education is vital.
As the old song goes: ‘It must be love, love, love’. Well for many advisers, it seems rather more like an awkward first date than a passionate embrace when it comes to exchange-traded funds (ETFs).
ETFs have certainly grown in popularity, but many advisers are still choosing to play the field rather than make a long-term commitment to these sexy new investment vehicles.
Morningstar Australasia co-head of fund research Tim Murphy believes many advisers are still wary and will need help – both from the market and providers – before ETF usage becomes commonplace.
“More education and a pick-up in the general sentiment in the market is needed. This will result in increasing adviser interest in new types of investments,” he explains.
BetaShares head of investment strategy Drew Corbett is more optimistic and believes ETFs are a product advisers are coming to cherish.
“There is growing acceptance and adoption of ETFs and the tide is coming in. It is a process of helping advisers understand how they work,” he says.
The arrival of the Future of Financial Advice (FOFA) reforms will “change the playing field” and heighten the attraction of low-cost ETF structures, Corbett says.
“Advisers are warming up to them now the implementation of FOFA is coming.”
According to Amanda Skelly, head of SSgA’s SPDR ETF operations in Australia, there is a range of reasons driving advisers to embrace ETFs.
“Acceptance is growing, with increased business being written. As increasing numbers of advisers come on board, costs are coming down,” she notes.
Vanguard’s head of product and marketing Robyn Laidlaw has found a positive response from planners to the new ETFs hitting the market.
“Advisers who are early adopters are saying it is a low-cost tool that is easy to implement and that clients like the transparency. They are also administratively easy to use in the adviser’s practice,” she notes.
However, Murphy believes many advisers are still cautious. “We are not seeing a wholesale embrace by many practices of ETFs at this stage.”
Skelly acknowledges there is some reluctance. “[Advisers] know managed funds and direct shares and how they work, but ETFs are new and this results in approaching them with caution.”
Education is vital
There is general agreement education is vital to further growth of the local ETF market.
“One of the key challenges is education, as most advice groups are still not using ETFs to any great extent. Most providers believe advisers need greater education to see how ETFs fit into portfolios and to gain a practical understanding about issues like execution,” Murphy says.
A key element of this is how ETFs can be used within the portfolio.
“Advisers need to ask what portfolio exposure they want to achieve. Do I want ASX200 or ASX300 exposure, or do I have a dividend focus etc.? Then the adviser needs research to understand the rules of each fund and which one to select,” he notes.
“For example, some Australian equity ETFs have greater small or mid-cap holdings and some have different suitability for various uses. Morningstar reports have a lot of information on the portfolio styles used by providers to create individual ETFs.”
Corbett believes once advisers become comfortable with the product structure, the industry can move to a more sophisticated stage.
“Advisers will need education about the underlying asset classes such as gold or global agriculture – soya beans or corn – and how these markets work and what makes prices move,” he explains.
Learning to trade
Providers are also keen to help build adviser knowledge around the intricacies of share market trading.
“If advisers have a high level of awareness of share trading they are often fairly comfortable [with ETFs], but for those who are more familiar with managed funds, it is something new to learn,” Laidlaw notes.
Murphy agrees advisers often need help with live trading and this means understanding the nuances of the trading process.
“With ETFs you need to understand the trading mechanisms and buy/sell spreads. Advisers need to understand how to get the best execution, such as not trading in the first or last half hour, as that is when you see lots of price discovery going on,” he says.
Providers like Vanguard have launched an ETF Trade and Execution Help Desk to assist advisers with trading and help them through the process, Laidlaw explains.
Aside from learning the terminology and implication of different share market orders, Murphy believes advisers need to carefully consider the pros and cons of the various listed investment products on offer.
“Advisers need to understand the differences between LICs [listed investment companies], ETFs, direct shares and managed funds,” he says.
Although they may seem similar, there are significant differences between LICs and ETFs, Laidlaw says, noting a LIC is a company, while an ETF is a trust.
Murphy points to an another important distinction. “LICs are closed-ended versus ETFs which are open-ended. With LICs the price is completely open to the vagaries of the market, while ETFs have obligated market makers who want to keep the price as close or near to NAV [net asset value] as possible.”
The fact LICs can trade at either a premium or a discount to NAV is an important point, Skelly notes.
“With LICs you don’t get transparency and some – although not all – have difficult fees that are hard to understand. Also, LICs can’t adjust the supply and demand of shares so they often trade at a premium or discount to price,” she explains.
“The premium can change to a discount very quickly as has occurred in the last few years. At the moment, LICs are all trading at a 2 per cent discount.”
According to Corbett, many investors incorrectly believe a LIC trading at a discount represents good value.
“While a LIC can trade at a discount to NAV, there is no mechanism to get what it is worth, so you are not able to capture the discount to the underlying value,” he notes.
The level of transparency is also an important difference between LICs and ETFs.
“ETFs need to show their holdings every day to the market, but it is not the same in LICs and managed funds,” Skelly says.
The final differentiator is the old active versus passive question.
“With LICs, you are really looking to achieve a return that is better than the market and so the ability of the firm to pick stocks is important, while an ETF is purely for tracking the market, less the fees,” explains Laidlaw.
Tips for trading ETFs
According to Morningstar’s Tim Murphy, there are several important ‘rules of thumb’ for efficiently trading ETFs:
• Stick to large, reputable providers with scale and expertise
• Check analyst research on their strengths and weaknesses
• Market makers are not always operating at market open and close
• Avoid the first and last 15 minutes of trading (longer for illiquid sectors)
• Avoid trading during the end of day auction period
• For ETFs holding foreign assets, wait until the relevant market is open (e.g. trade when the Asian exchanges are open)
• Check the ETF’s market price is close to the published NAV
• Check trading volumes for an indication of liquidity
• Check premium and discount figures
• Check the bid/ask spread
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