Ilan Israelstam, Head of Strategy at BetaShares, looks at the past, present, and future, of ETFs on the Australian market.
The first exchange traded fund (
ETF) was quoted on the Australian Securities Exchange (ASX) on 27 August 2001, and while growth was slow in the early days, since 2009, assets under management of Australian Exchange Traded Products (ETP) have doubled, with approximately $5.5 billion invested as of August 2012. The last 12 months in particular have been significant in terms of the development of the Australian ETF industry, with all major asset classes now available for investors in ETF form. In addition, new money into the industry was significantly positive – with over $200m of net net inflows in the last 6 months alone.
Additionally, the number of products and exposures now available on the ASX has increased substantially, with 26 new ETPs listed since June 2011. To put this number in context, in July 2010, almost nine years after the first ETF was launched in Australia, there were only 37 ETPs quoted on the ASX, and in the last two years, we have seen this number more than double. Of the 26 new ETPs listed on the ASX since July 2011, investors now have exposure to a range of currencies, fixed income, cash and commodities such as agriculture and oil. With all these asset classes now available, we are also beginning to see greater interest and some investment in ETFs by institutional investors.
Institutional Investors’ Usage Still Limited – but Significant Upside Available
While there has been plenty of interest in ETFs by Australian institutions, uptake has been limited to date. However, despite this, activity has definitely picked up in the last 12 months including initial ETF investments by SunSuper, a major Australian pension fund, and van Eyk, a multi-manager, both allocating to emerging markets through ETFs. Recently, there has also been institutional use of the US dollar ETF (which aims to profit from a fall in the Australian dollar against the US dollar), as well as in the high interest cash ETF (which aims to provide returns greater than the Reserve Bank of Australia cash rate). Just recently, a resources sector ETF experienced some block trading as institutional investors looked to obtain tactical tilts to Australia’s largest sector of the economy. The above progress notwithstanding, there is still a long way to go. In other markets such as Europe or the US, up to 50% of ETF assets under management are institutional and ETFs are almost always in the top 10 securities traded in terms of exchange turnover. Compare this with Australia, where ETFs only make up a small portion of the total trading value, with a majority of the money retail based. It appears as though significant upside still exists for institutional usage of ETFs in Australia.
The Attractiveness of the Australian ETF Market
Despite not being as advanced as other ETF markets, there are some characteristics for Australian ETF issuers which make the local market attractive. First off, by sheer virtue of being a laggard market, local ETF issuers and regulators can learn from the scrutiny of ETFs that occurs in more developed markets, especially when it comes to regulatory issues. As an example, Australian ETF structures benefit from ‘best practice’ in existence around the globe. To illustrate this, currently all ‘synthetic’ ETFs listed in Australia are backed by cash held in a depositary account. Such a structure avoids some of the controversy that occurred when similar ETFs quoted in overseas markets utilised alternative forms of collateral in their structures. The second point is that the Australian ETF market has a lot of room to grow. If we compare Australia to Canada, there are a lot of similarities in terms of GDP, population size and being a resources driven economy. However, there is a huge difference in terms of size of the ETF market with the Canadian industry being approximately C$40 billion compared with just over A$5 billion locally. The size of the potential is particularly striking when one notes that Australia has the fourth largest pension pool in the world, just having tipped A$1.4 trillion. This clearly presents strong growth opportunities for ETFs as retail and institutional investors continue adopting ETFs in portfolios. Depending on market conditions, we believe the Australian ETF market has potential to grow exponentially over the next three years reaching up to A$15 billion by 2015.Alternative Asset Classes
ETFs are access vehicles for investors providing the opportunity to gain exposure to a variety of asset classes in a simple, transparent and liquid manner. Outside of core Australian equities exposures, investors can now access fixed income, cash, commodities such as oil and agriculture, as well as precious metals such as gold, on the ASX.Traditionally, Australian investors are more heavily weighted towards domestic equities compared with global counterparts. Most Australian superannuation funds can allocate anywhere between 30% – 40% of portfolios to Australian equities, a very high level when compared with overseas pension markets. Now that there exists direct access to fixed income, commodities and previously available asset classes of domestic and global equities, investors can now access all the asset classes of a balanced portfolio and tailor their exposure depending on their risk profile. As an example of further access made available via ETPs, in July the first “bear fund” was launched in Australia. As the product is designed to go up when the sharemarket falls (and vice versa), it allows investors to profit from or hedge against a decline in Australian shares.
Future of ETFs in Australia
ETFs on global exchanges provide a reflection of investor sentiment, and fund flows of larger ETFs are actually a gauge of the risk appetite of the market. Although Australian ETFs have not reached this size, local products do provide a barometer for risk appetite. Currently the flows indicate that risk appetite is subdued resulting in very little inflows to Australian equities based products. Despite this, Australian investors may have finally turned the corner with renewed interest in Australian equities during July, with 6 of the top 10 funds by inflows being Australian equities based. The other continuing trend is dividend and yield based strategies which are continuing to prove popular among investors. With capital return expectations low and investors looking to yields for returns, they now have the option of fixed income ETFs, and recently the first cash ETF, available on the ASX. While fixed income ETFs have been popular overseas, the market in Australia is still in its infancy and has not yet enjoyed the same success compared with overseas markets. During the first half of 2012, fixed income ETFs attracted just over $40 billion in new assets globally, which accounted for approximately 40% of all global inflows. Also, lack of investor conviction has resulted in lower trading volumes on the Australian Securities Exchange but the various ETFs which track Australian equities indices have continued to prove popular as both trading instruments and longer term buys. Innovation can sometimes be dependent on the market and in the case of Australia, the first cash ETF to be quoted has grown strongly due to the market dynamics. With one of the highest interest rates in the developed world, investors can now access high Australian interest rates through the cash ETF in a simple, transparent and liquid manner on the ASX. Notwithstanding a great deal of product innovation, by global standards, the range of listed exposures available to Australian investors is still very narrow. As such, we expect there to be continued product innovation over the coming year. Such innovation c
ould include more thematic and strategy based ETFs. As the menu of products continues to fill out, we expect further adoption, both retail and institutional, as the ETF market continues its growth trajectory.
