ETFs: The Ultimate Guide

The amount we are investing in ETFs has doubled in less than two years ... and the choice has just improved again.

Summary: There are now 96 exchange-traded funds available to you locally and over 5,000 internationally from which you can build a diversified portfolio.
Key take out: Australians have doubled their use of ETFs since I reviewed the local product range nearly two years ago. Should you?
Key beneficiaries: General Investors. Category: Investment Portfolio Construction.

The amount of funds invested in locally-listed ETFs (Exchange Traded Funds) has doubled to $12 billion since I shared with you in October 2012 a comprehensive summary of the Australian ETF landscape and uniquely then, portfolios you could build solely from them. Let me summarise for you here what’s changed and what more you can do. 

More suppliers, more products, more innovation and our first delisting

Figure 1 summarises the range of ETPs currently available in Australia. Note the term exchange traded products (ETPs) is the technically correct description of products that include funds based on traditional securities (ETFs) and those based on commodities (ETCs).

Figure 1: Australian ETF landscape at 15 August 2014

Asset Class               SupplieriShares BlackrockSSgA    SPDRVanguardBeta SharesETF             SecuritiesRussellAiiMarket VectorsOther
Australian equity
Large only ILCSFYVLC
Index IOZSTWVAS
SmallISOSSOVSO
ValueRVL
High dividendIHDSYIVHYRDVDIV, AOD
ShortingBEAR
Buy WriteYMAX
Alternative IndexQOZMVWETF
GearedGEAR
Industry sectorOZF, OZRQFN,QREFIN, FIX, RSR, IDD, ENY, MAMMVB, MVE, MVRDGA
International equity 
Large globalIOOWXOZ, WXHG
US largeIVVVTS
US smallerIRU,IJH, IJR
ex-USIVEVEU
EuropeIEU
AsiaIAA
Emerging MarketsIEM, IBKWEMGVGE
CountryIZZ,IKO, ITW,IHK, IJP,ISG
Industry sectorIXI,IXJ,IXP
High DividendWDIV
Property
Australian listed propertySLFVAPMVA
Global listed propertyDJRE
Commodity
Multi-commodity basketQCBETPCMDRBSRIG
GoldQAUGOLDPMGOLD
Other metalsETPMAG, ETPMPT, ETPMPD, ETPMPM, ETPIND, ETPCOP
Oil and energyOOOETPNRG, ETPOIL, ETPGASRBSRIE
AgriculturalQAGETPAGR, ETPGRN, ETPCRN, ETPWHT
Australian Bond
Composite indexIAFBONDVAF
Government nominalIGBGOVTVGBRGB, RSM
Government inflation linkedILB
CorporateRCB
Cash
AustralianAAA
British PoundPOU
EuroEEU
US DollarUSD
Total no. of ETFs offered 9626141014155057
* Chimaera (DGA), UBS (DIV, ETF), Aurora (AOD), Perth Mint Gold (PMGOLD), RBS RICI Enhanced Indices (RBSRIG, RBSRIE)
 © Professional Wealth as at 12 August 2014

Changes include:

  • A net increase in suppliers from eight to 11, including four additions and one subtraction;
  • The new suppliers are Market Vectors, RBS, UBS, Aurora and the Perth Mint;
  • The delisting of six ETFs from Aii Securities is a reminder that with fees so low, ETFs aren’t profitable to suppliers unless they attract sufficient funds;
  • A net increase in products of 11 to 96 (a gross increase of 17);
  • New category of ETFs offered by three different suppliers which invest differently in Australia’s unusually concentrated index (see Goodbye to the ‘All Ordinaries); these funds would be considered “Smart Beta” style, which subtly implies traditional indexing is “Dumb Beta”;
  • Fund GEAR that borrows internally to amplify the returns from investing in Australian shares;
  • Fund YMAX, which sells derivative contracts to increase income, funded from capping capital gain;
  • Fund DJRE, which invests in global property, complementing three other funds that invest in local listed property;
  • The first currency-hedged international equity fund WXHG, complementing the first all global, excluding Australia all-in-one (not regional) fund. The unhedged version is WXOZ. For those tired of or confused about filling out IRS W8-BEN forms or worried about US Estate taxes, these international funds are homemade and not cross-listed overseas funds;
  • A high dividend international equity fund WDIV (which could have offered higher income if it too was currency hedged, as explained earlier Hedging’s little extra);
  • More actively managed (and costly) funds being offered through new “AQUA” listing rules.  Those offered by UBS, for instance, back their researcher’s buy/sell/hold recommendations whose performance over time will be interesting to watch;
  • RBSRIE and RBS RIG are new exchange-traded “certificates” that provide, along with the offerings from ETF Securities, a “synthetic” structured-product, non-physical exposure to commodity prices;
  • Somewhat “me-too” funds investing in emerging market, Australian bonds, gold, energy, AREIT and local high dividend companies.

Life’s 80/20 rule applies to ETF investing. That is the top 20 ETFs account for about 80% of total monies invested. The top 10 ETFs (in order of decreasing size: STW, IVV, VAS, IOO, AAA, SLF, GOLD, VHY, SFY, VTS) account for two-thirds. Delisted Aii funds found themselves in the long tail of this distribution. While $12 billion sounds like a lot, based on an average fund fee of 0.2%, $24 million in recurring revenues won’t feed 11 product suppliers.

Don’t worry suppliers are in it for the long haul, expecting to match success overseas. Globally Blackrock burst through an amazing $US1 trillion invested in its ETFs, followed by State Street and Vanguard, looking after about $US400 billion each of investor monies. Wisdom Tree, the eighth biggest, just announced an alliance with the local BetaShares, itself a subsidiary of Asian company Mirae Asset Global Investments. World number 13, Van Eck Securities is behind the new entrant Market Vectors Australia, but also was associated with delisted provider Aii.

Portfolios

In my earlier all-ETFS pie article I pointed out that you could build fully diversified portfolios entirely from Australian ETFs. I don’t need to update those as ETF suppliers have started to do that for you. Blackrock, for instance, present five different multi-sector, model portfolios ranging from Conservative to Aggressive mixes (Figure 2). Not surprisingly, these are built entirely out of ishares by Blackrock ETFs. Available with an ongoing MER of less than 0.2% they offer a substantial fee discount to long-term favourite unlisted “Diversified” variants offered by Vanguard also built on index funds. To be fair, the Vanguard diversified variants are an all-in-one, automatically rebalanced construction and can be bought directly, brokerage-free from Vanguard. For small investors their retail starting fee of 0.9% falling to 0.35% would still be cheaper and easier to maintain.

The returns from these portfolios over a very short first year to March 31, 2014 neatly show the trade-off between return and risk – even though during this year equities offered an above-average return for below-average volatility. Do I need to remind you past returns are no guide of future returns?
Graph for ETFs: The Ultimate Guide


Graph for ETFs: The Ultimate Guide

Offshore ETFs?

As at June 2014, there are $US2.6 trillion globally invested in about 5,400 ETFs (numbers already out of date). So if you feel artistically limited by investing, using a palette of only 96 Australian domiciled ETFs, then by using a local broker offering access to international markets or an overseas broker you can expand this by 50 times. If doing so, you’ll definitely need to have firm views on what you do and don’t believe.

David Gilmour provided a useful guide (Buying overseas stocks: A Eureka Guide) about investing in overseas stocks, which would include overseas listed ETFs. Aside from using some of the full-service brokers, discount brokers COMMSEC and E*Trade let you trade on foreign exchanges including the US and Europe, where 4,000 of these ETFs are listed. There are, of course, different levels of service in these options.

Issues with investing directly in markets outside Australia include:

  • Higher brokerage fees: 0.6-1% versus about 0.1% locally (for COMMSEC and E*Trade);
  • Ongoing administration and custodian fees ($ or % based), not usually payable on ASX accounts, reducing the benefit of investing in low-cost ETFs;
  • Use of foreign custodians, who may hold your cash or securities in their name;
  • Potential for withholding taxes, which may not be offset and higher than investing in a fund that does a better job claiming double tax treaty exemptions;
  • Losses on currency exchange charged at generous spreads;
  • Possible estate tax (though still possible with Australian cross-listed international ETFs);
  • Greater likelihood that your fund’s share and bond holdings are lent to others for purposes of short-selling or vote rigging;
  • Greater use of “synthetic” funds holding derivatives instead of underlying assets;
  • … and the need to stay up late at night to trade!

So, unless you have a strong belief that you need to invest narrowly in companies in the water business (CGW listed on the NYSE), social media (SOCL.NYSE) or speculate on the prices of say uranium (URA.NYSEA), natural gas (GAZ.NYSE) or lean pork (HOGS.NYSE)  … then I think it is safer and cheaper to invest locally.

Australian investors are still catching up with investors overseas, who utilise ETFs more widely. Some of this is for structural reasons; for instance, our local market being small enough to bypass bank share ETFs (MVB, OZF, QFN). Nevertheless, I remain of the view that it is entirely reasonable to invest using a diversified portfolio solely of ETFs. You now have 11 more reasons to think about doing so.


Dr Doug Turek is Principal Advisor of independently owned advice and money management firm Professional Wealth Pty Ltd (www.professionalwealth.com.au)