ETFs: Investors Up the Ante and ETFs Run the Show for Long-Term Returns

ETFs are one of the best investment products if you are looking for diversified returns, low capital investment and returns similar to an index or a commodity. They are considered to be one of investors’ favourite because of the passive income opportunity they present. In the Australian market, more than 200 ETFs are listed. Let’s dig deeper to understand this investing form and its stance amid the pandemic turmoil.

What are ETFs?

An ETF or exchange traded fund comprises assets such as stocks (both domestic and international), commodities, precious metals like gold, safe investment options such as bonds, and currencies. Operating as a managed fund, ETFs are traded on an exchange, like ASX (Australian Securities Exchange).

An ETF primarily follows an index and in general don’t outperform the index it tracks, but exceptional growth could occur. For example, the below chart where STW Fund is tracking the S&P/ASX 200 index, percentage change in prices of the index is mirrored by percentage changes in the price of the ETF. The chart also shows that in March 2020, when Australia was majorly dealing with the COVID-19 pandemic, S&P/SX 200 experienced a sharp decline with the ETF being no exception.

Fig 1: STW Fund vs S&P/ASX 200 – One-Year Price Performance

For more information, please read Points To Consider While Investing In ETFs?

ETFs and the Australian Market

As per data released by the ASX and Vanguard, one of the world's largest investment companies, the Australian Exchange Traded Fund (ETF) market crossed $61 billion in assets under management (AUM) in 2019. Inflows for the year reached over $13.7 billion. ETF industry inflows for 2019 far outpaced $8.0 billion and $6.4 billion received in 2017 and 2018, respectively, with ETF assets growing at a compound annual growth rate (CAGR) of over 23% for the past five years.

According to investment advisor Vanguard and the ASX, new ETF inflows in the first quarter of 2020 were $3.8 billion. 1Q20 was also the third strongest quarter on record for the Australian ETF market in terms of new inflows.

According to Minh Tieu, Head of ETF Capital Markets for Asia Pacific at Vanguard, 2019 observed a challenging market because of the Australian federal election, international issues such as the US and China trade war and Brexit, along with adapting to the findings of the Royal Commission. Amid such market conditions, the ETF market continued to show resilience with more investors choosing ETFs, leading to increased competition among issuers, which in turn drove down the cost to invest, giving investors more returns.

As on 31 March 2020, Vanguard remains the largest ETF manager in Australia, with AUM of $17.6 billion and 29 ETF offered products.

Why ETFs are a Good Option for Long-Term Investment?

• ETFs provide low-cost investment opportunity with minimal management fees. They are also more cost-efficient than actively managed funds with a low management expense ratio (MER) and are usually cheaper than most actively managed funds.
• ETFs provide a range of shares to be traded under one basket in a single trade. They are built using an indexing approach and allow investors to access a wider range of investments, such as markets or assets that are difficult or expensive to access. Diversification also spreads the risk creating a safe bucket of stocks to trade on stock exchange.
• Daily information on the ETF basket and its Net Asset Value (NAV) is provided by the issuer to the market. This helps investors to track how the ETF is performing with respect to its NAV. This creates transparency, making ETF a transparent investment option.
• ETFs are traded during ASX trading hours which enables investors to create and convert ETF securities ensuring an underlying depth of liquidity.

What to consider during ETF investing?

• As an ETF tracks an index, performance of the index reflects the performance of the ETF. If the value of an index falls, the value of the ETF investment will also fall.
• As currencies are also subject to high and low performance, if an ETF has invested in international assets, the price fluctuations of the international currency would impact the returns on ETFs. As a solution, an investor can hedge the ETF and eliminate the risk.
• Some ETFs comprise non-liquid assets, making it difficult to create or redeem securities.

Must Read! Looking to invest in ETFs? 5 Tips for ETF investors

ETFs give access to a range of assets and markets, both at domestic and global levels, thereby delivering benefits like instant diversification, asset allocation adjustments, and potential returns in terms of income and capital growth, provided they are used wisely. As they also carry risks, one should make a decision regarding ETF sale or purchase, considering how much risk one can assume to get to the desired results.

Disclaimer: All the currencies mentioned are in AUD unless specified