CPD: How digital advice is propelling the ETF industry

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While digital advice – online wealth management services that provide automated, algorithm-based portfolio management advice – will never replace human advisers, it can be beneficial to complement traditional advice services with low-touch digital advice solutions to Australians currently not able to afford a traditional advice process.

Digital advice providers offer investment advice options to align to clients’ personal circumstances. These investment portfolios typically consist of exchange-traded funds (ETFs) and managed funds to create well-constructed portfolios which are well diversified by asset class and geography.

A close look at ETFs

Listed on a stock exchange – the Australian Securities Exchange (ASX) for example – ETFs are a transparent and simple way for investors to gain exposure to investments such as shares, property and bonds.

Indexing is becoming a popular investment trend, and ETFs have the best of both worlds, by offering indexing and trading in the same investment structure.

The benefits of ETFs are wide ranging and include;

Low cost investment vehicles that often perform consistently in line with a particular allocation

As passively managed investments that track the benchmark index, ETFs do not rely on sophisticated investment research. Trying to ‘beat’ the market can be an expensive venture and many actively managed funds have higher costs associated. In comparison, an ETF’s fees are typically below one per cent and generally perform better than more active funds over time.

Cost effective

Beyond the fees charged, ETFs can be more cost effective than direct share investing as they have a lower active risk to the investor. Further, passive management means that management fees won’t eat into investors’ savings.

Provide diversification for investors

As more retail investors savvy up to the risks of “putting all their eggs in one basket,” ETFs are valuable as they provide broad exposure to all markets within a relevant index for diversification – it is diversification which can generate the most value for investors.

Tax efficiency for investors

ETFs generally have a lower turnover, minimising the impact of capital gains tax as fewer capital gains are realised.

Transparency

Most ETFs provide regular information – including daily fund Net Asset Values – to the market, increasing transparency for investors

Enables rebalancing

An ETF can be rebalanced to its original weighting, resulting in less skewed asset allocation, reduced investment risk, and better returns for investors.

Offers liquidity

ETFs are open-ended funds and underlying securities can be easily traded or sold. According to the Reserve Bank of Australia (RBA), ETF turnover averaged $AU60 million per day and trading activity can swing dramatically dependent on where there are larger issues and redemptions of ETFs.

Provides an alternative to direct-share investing

Many retail investors are attracted to the idea of trading securities on the share market however may not feel confident placing an order on the ASX through a broker. Hence, ETFs provide an investment solution to layman investors.

Growth in ETFs

As you may already be aware, ETFs are currently among the most disruptive forces in the investment industry – and Australian investors are avid purchasers of ETFs.

The first ETF was created in 1993 and since then their popularity has skyrocketed.

Advances in technology and data analytics have significantly contributed to recent growth and innovation of ETFs, particularly in relation to product creation and distribution[1].

Approximately $380 billion has entered the ETF market so far in 2017, exceeding the previous record set in 2015. In the US, ETFs accounted for 30 per cent of all trading in terms of value in 2016 and 23 per cent by share volume[2]. More impressively, seven of the 10 most actively traded securities on the US share market were actually ETFs.

Locally, the Australian domestic ETF market is now worth close to $30 billion and has recorded a compound annual growth of 35 per cent, with no signs of slowing.

In fact, it is expected to grow strongly with new products added to the ASX every month[3]. We have no shortage of new ETF funds being added to the ASX, with figures showing in financial year 16-17 the actual number of new ETF funds added came close to $6 billion[4].

Currently, ETFs make up around 1.5 per cent of the total domestic market capitalisation, however in larger international economies including the US and Europe, ETFs account for around 10 per cent[5].

The most common type of ETFs are domestic equity ETFs, which make up 44 per cent of the ETF market and track a broad-based index like the ASX 200, and international equity ETFs which make up up almost 40 per cent and track European, Asian and emerging markets[6].

Interestingly, only four of the world’s 30 largest economies aren’t represented on any ETFs listed on the US stock exchange. Those countries are Iran, Saudi Arabia, Argentina and Pakistan. Israel is the smallest economy to have its own US-listed ETF, currently sitting at 8.10 per cent capital growth for YTD – pretty impressive[7].

Considerations around ETFs

It is useful to understand the common reasons why retail investors can be wary about investing in an ETF.

Some retail investors and market commentators have expressed concern around the pace of inflows into ETFs, and the prospect of this resulting in a price bubble on the share market. However, investors continue to buy shares directly as well as through managed funds and other products, meaning the demand is there and ETFs are simply another investment vehicle.

Other investors point to a supply and demand mismatch, and the possibility of a price hike due to the sheer number of investors accessing ETFs. However, ETFs can issue additional units for trade when necessary.

Some investors express concern around the ‘passive’ aspect of ETFs. That is to say, they feel more comfortable with actively managed investment vehicles.

These same investors typically perceive as a risk that an ETF’s performance could diverge widely from the index, resulting in greater losses. However, the risk of an ETF being outperformed by an actively managed fund – such as an unlisted or listed managed fund – is countered by the significantly lower investment management cost than an ETF generally has.

Although pricing changes can be as subtle as a few percentage points between an ETF and a similarly allocated actively managed fund, when averaged out over longer periods of time these costs can prove ETFs to be extremely competitive, even if the active fund had outperformed the passive fund in the past. In fact, ETFs are, on average, 68 basis points cheaper than competitor managed funds and the number of ETF investors increased 31 per cent in the 12 months to September 2016[8].

Robo-advice: a key distribution channel for the ETF industry

Modern technology has made trading ETFs a simpler process. Increasingly, retail investors and financial advisers are becoming more confident in using digital advice platforms or for investing or doing their own research.

Digital advice platforms offer transparent reporting coupled with online or phone general and personal advice, allowing professional advisers to educate their clients on the wide world of ETFs.

This growth in digital advice solutions has also propelled the ETF industry by effectively becoming a new distribution channel for ETFs. A recent survey from EY[9] showed 80 per cent of respondents expect robo-advice providers to accelerate ETF growth and 45 per cent believe they will deliver more than 10 per cent of annual inflows to ETFs within a three to five-year timeframe.

How to choose a robo-advice provider

Whether or not your financial planning firm has already embraced digital advice, it is difficult to overlook the advantages to retail investors, and opportunities for growth for advice firms.

Currently, just one-in-five Australians receives professional financial advice so there is enormous opportunity to increase the number of advised-Australians[10].

Importantly, boosting this statistic is a priority for ASIC. However, the cost of delivering traditional advice remains a prohibitor, as does ensuring advice provided takes into account fiduciary duties to clients.

Digital advice can bridge the gap.

For firms looking to go down the digital-advice path, ensure you choose a provider that has compliance at its core to meet Best Interest Duty (BID) obligations, invests in research, and utilises products from leading investment management houses.

For example, Ignition Wealth is guided by research from Lonsec and a professional Investment Committee oversees all investment activity. It blends a number of ETFs from investment leaders including BlackRock, Vanguard and State Street to create model investment portfolios to provide a range of options to investors depending on their risk profile.

Ultimately, ETFs represent a largely untapped market for advisers and clients alike.

As Australians continue to embrace digital channels for engaging with their finances, ETFs will continue to grow in appeal. Ignition Wealth encourages people looking at commencing their investment journey to look at ETFs.

It can be an incubation process, allowing investors to enter the market, understand their risk profile, get to know some of the ETF players such as Vanguard, BlackRock, State Street and Beta Shares and being educated in their investment options.

Understanding where they can fit into your clients’ investment portfolio will enable your firm to continue leading the conversation and remain the trusted adviser.

 

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[1] PricewaterhouseCoopers, A Roadmap to Growth: https://www.pwc.com/gx/en/asset-management/publications/pdfs/etfs-a-roadmap-to-growth.pdf
[2] Financial Times: https://www.ft.com/content/6dabad28-e19c-11e6-9645-c9357a75844a?mhq5j=e5
[3] The Australian: http://www.theaustralian.com.au/business/wealth/three-things-you-must-know-about-etfs/news-story/ce873a15e2a599e8fe6bbd4ca3b45eac
[4] The Australian: http://www.theaustralian.com.au/business/wealth/etf-boom-on-wall-street-and-in-australia/news-story/e07be48516b24d5cda431564344dab80
[5] Reserve Bank of Australia, June 2017 https://www.rba.gov.au/publications/bulletin/2017/jun/pdf/bu-0617-6-the-australian-exchange-traded-funds-market.pdf
[6] Reserve Bank of Australia, June 2017 https://www.rba.gov.au/publications/bulletin/2017/jun/pdf/bu-0617-6-the-australian-exchange-traded-funds-market.pdf
[7] ETFdb.com: http://etfdb.com/type/region/middle-east/israel/
[8] BetaShares: https://www.betashares.com.au/campaigns/betashares-investment-trends-etf-report/
[9] EY Global ETF Survey 2016 Integrated innovation: The key to sustainable growth: http://www.ey.com/gl/en/newsroom/news-releases/news-ey-exchange-traded-fund-market-set-to-nearly-double-by-2020
[10] Professional Planner: https://www.professionalplanner.com.au/cut-and-paste/2016/05/12/80-per-cent-of-australians-do-not-currently-use-or-intend-to-use-a-financial-planner-46110/

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