InvestSMART Australian Exchange-Traded Fund Quarterly Report - June 2018

About this report

Welcome to InvestSMART’s June Quarter 2018 Australian Exchange-Traded Products (ETP) update.

Exchange Traded Funds (ETFs) form the basis of a range of InvestSMART’s Separately Managed Account (SMA) portfolios. The purpose of this report is to provide our clients with an easy to digest wrap of market activity as well as provide a greater level of insight into how and why we’ve built our SMA portfolios the way we have. 

ETFs are a low-cost, hassle-free way for investors to achieve their investment objectives. Whether your aim is to diversify your portfolio or to obtain exposure to a particular investment theme, the ability to buy ETFs directly on market, their low cost and transparency has seen the popularity of these securities amongst investors grow rapidly.

We have categorised the ETP market by asset class to allow members to quickly identify suitable securities to fill any investment gaps in their portfolio and remain aligned to their specific investment objectives.

Figure 1: Asset Classes

About InvestSMART

InvestSMART Star Rating

When reviewing an ETF there are some key quantifiable metrics common to every security. 

To save time in reviewing each and every ETF listed on the Australian Market, we have developed a Quantitative 5 Star Rating System that takes each of these items into account. It is reflective of the process we use to identify investments for our own SMA portfolios.

For our portfolios, we generally like to see a 4 to 5-star rating, as this implies the security rates well across each of the above-mentioned metrics. However, the star rating is best used as a filtering tool when comparing ETFs with the same objective. It does not make sense to compare a highly liquid, and hence low-cost S&P500 ETF to one designed to track the performance of emerging markets which are often less liquid and more expensive to access.

It should also be noted that the InvestSMART Star Rating is a quantitative measure and it does not take one’s investment objectives into account. The InvestSMART Star ratings do not constitute recommendations. Additionally, we do not rate Actively Managed Funds or Structured products, and this is denoted by an NR or “Not Rated”.

Figure 3: Number of ETFs per star rating

Star Rating	Number of ETFs
5	7
4	31
3	58
2	42
1	4
NA	34

Highlights this Quarter

InvestSMART launches its first active ETF - Australian Equity Income Fund (ASX:INIF)

During the month of June, we listed our very own listed managed fund, or active ETF. The InvestSMART Australian Equity Income Fund (ASX: INIF) is based on the same portfolio we have managed under the Separately Managed Account (SMA) structure for the past 3 years.

The primary objectives of the Fund are to achieve attractive risk-adjusted returns over the medium to long-term while reducing the risk of permanent capital loss. Investors get exposure to active management of a concentrated portfolio of well-researched Australian equities with a sustainable high yield. 

You can view the most up to date fund information here.

How does the fund select investments?

The investment approach is buying and holding shares with market prices at material discounts to their estimated value and high sustainable yields. Investments will be sold if they move to a material premium to their estimated value, or the dividend yield is expected to fall.

Key Features

Figure 4: Key Features 

^As at 30 June 2018. *Per ASX investment products monthly update, June 2018

Portfolio Characteristics

Figure 5: Asset Allocation	Figure 6: Top 10
	Top 10
	Code	Weight
	TME	6.61%
	SEK	5.11%
	ASX	4.88%
	WES	4.80%
	WPL	4.74%
	BHP	4.70%
	CBA	4.64%
	SCG	4.62%
	LEP	4.52%
	SYD	4.32%

As at 30 June 2018

Performance – Historical

INIF is based on the same portfolio we have managed under the Separately Managed Account (SMA) structure for the past 3 years, the performance of which is noted below.

Figure 7: Intelligent Investor Equity Income - Performance to 30 June 2018

FAQs

iNAV stands for Indicative Net Asset Value. The Net Asset Value (NAV) is calculated by deducting all liabilities (including fees) from the total value of the Fund’s assets and dividing this number by the number of Units on issue.

During each ASX Trading Day, an indicative NAV (iNAV) is published to take into account any movement of the prices of those securities that comprise the Fund's investment portfolio. This is unlike a traditional unlisted fund, which will only provide a unit price once daily. We publish our iNAV and a history of the day end NAV here.

When will the distribution be paid and what is it made up of?

The distribution will be twice a year after the end of financial year and calendar year. The distribution is made up of all income received by the Fund. This includes dividends paid, interest earned on cash and realised capital gains.

Yes. At the end of financial year you will be issued a tax statement. The timing of the issuing of the tax statement may vary depending on the holdings of the Fund. If, for instance, the Fund invests in any listed trusts such as real estate investment trusts (REITs), the Fund will need to wait until the REITs issue an annual report before the Fund can complete the tax statements.

You can find the full list of frequently asked questions on our website. 

What is the difference between ETFs, Active ETFs, LICs & mFunds?

When the first ETFs were listed they were quite simple products. They were designed to track well known, broad based equity indices, for example the S&P ASX200. However, with the advent of actively managed and Smart Beta ETFs in recent years, the lines between the traditionally passive ETF and the actively managed unlisted funds and LICs have started to blur, confusing some investors.

Exchange Traded Funds (ETF)

An ETF is a passive fund that seeks to replicate or track the performance of an index, specified combination of multiple indices, or other widely regarded benchmark, the value of which is continuously disclosed, or can be immediately determined.

Active ETF or Exchange Traded/Quoted Managed Funds (ETMF/EQMF)

An Active ETF or EQMF/ETMF is one that buy or sells investments based on an active investment strategy or where they seek to outperform a particular benchmark. Due to being actively managed, they often charge higher fees than passive ETFs. We wrote about the differences between active and passive ETFs in last quarters ETF report.

InvestSMART launched its first active ETF (listed fund) June 2018. Trading under ticker code: INIF, the listed fund mirrors the group’s existing unlisted Intelligent Investor Equity Income Portfolio which is desisgned to deliver investors exposure to a concentrated portfolio of up to 30 Australian equities with a sustainable income and around , actively managed by a team that has a research track record of more than 20 years.

You can find our ETF filtering tool here.

Listed Investment Companies (LIC)

Like ETFs, a LIC is simply a portfolio of assets managed by a professional fund manager. However, they differ in that they are closed ended and incorporated as companies as opposed to trusts. As LICs are companies, they have the option to retain or pay dividends.

You can find our LIC filtering tool here.

mFunds (mFund)

An mFund product is simply an unlisted managed fund that is available to investors via the ASX. The service allows investors to buy/sell units in a range of funds in the same way as they do for ordinary shares, removing the need to fill out forms each time you wish to transact. 

Figure 8: Difference between Fund Types

Funds Under Management

The Australian ETP market grew 7.5% during the June Qtr to close just shy of $40bn at 30 June. During the quarter there were 7 new products listed to take the total up to 183. There were also two new issuers to market with eInvest (EIGA) and InvestSMART (INIF) launching a fund each.

It is interesting to note that of the 10 new funds listed in the last 6 months, 8 of which are considered “Managed Funds” (MF). We expect to see, more MF structured listings as technology becomes available to smaller issuers, making it possible for them to list their products on market. We’ve had positive feedback from our own clients who appreciate the relative low cost and ease at which they can access these funds. As the ETF market matures, we also expect to see more factor based/themed funds.

Figure 9: Market Growth

Figure 10: FUM Growth - Inflows vs Performance

Figure 11: ETP Market Breakdown by Issuer

Figure 12: Australian ETP Market Breakdown

Asset Class The largest asset class in terms of both product range as well as FUM is equities, representing over 75% of the market.	Geography Geographically, the largest exposure for ETFs across the market is Australia, followed by those providing diversified global exposure.	Issuer With combined FUM of over $30 billion, close to 90% of the Australian ETFs market is managed by five issuers, namely BlackRock, Vanguard, State Street, BetaShares and Magellan.

Figure 10: FUM Growth - Inflows vs Performance

Figure 14: Product Breakdown by Structure

Market Flows

“Equity World Large Blend” ETFs saw strong inflows, with 50% going to Vanguard, via their MSCI International ETF (VGS) and All-World ex US ETF (VEU) ETFs alone. “Equity World Other” however saw the largest net outflows. This was due in part to iShares decision to close down 5 of their ETFs, IRU, IXP, ISG, IHK & IBK*. Three of the five fall within this category.

These delisting’s came as part of iShares decision to convert a range of their internationally domiciled ETFs to be Australian domiciled. This removes the need to fill out the W8-BEN forms which we see as a positive as well as allowing investors to now participate in DRPs.

*Note, we have retained these 5 ETFs as part of our analysis as they were delisted on the 22^nd of June. They will be removed in future reports.

Figure 15: Quarterly Flows

Figure 16: Cumulative FUM Flows ($M)

Figure 17: FUM Flows ($M) by Asset Class

Figure 18: Largest Inlows (QTR)

Figure 19: Largest Outlows (QTR)

Performance

Four of the five best performing ETFs this quarter were exposed to resources, led in the main by the surge in oil pricing across the three main contracts lead by WTI adding 14% in the quarter.

Figure 20: World Oil Markets

Figure 21: Top Five Performing Securities

Figure 22: Worst Five Performing Securities

Figure 23: Returns

3 months	12 months

Figure 24: Sub-category volatility

Emerging markets and Asia focused ETFs were prevalent amongst the worst performers. This was due to China’s main indices entering bear markets on the beginning of the US-China trade war and concerns that debt at State-Owed Enterprises (SOE) led Beijing ramp up its financial stability program and reduce the debt risk by enacting debt reduction programs across the country.

Future Flows

Looking at the future flow of funds, already there is a clear drive to US markets – in particularly in equities and US currencies. S&P500 second-quarter earnings is on pace for its best quarter since Q4 2010 as earnings-per-share (EPS) growth hits 29% year-on-year (YoY). Stripping out FAANG firms (Facebook, Apple, Amazon, Netflix, Google), YoY EPS growth alone was 37%. The caveat, forward guidance is being coloured by the recent enacted trade tariffs and a slowing of overall global output.

Flows into fixed income markets, particularly US fixed income, will be interesting over the coming period. Currently there are a further six rate hikes forecasted by the Federal Reserve come December 2019.  However pricing in the US bond market has been rather dislocated with the 2 year bond pricing in these hikes accordingly, the 10 year bond however has remained depressed suggesting the market sees some longer term risk to higher rates. The flattening yield curve may be a signal to risk investment which would mean some short term volatility in equities.

Looking to other parts of the fixed income market, for the first time since the GFC, the yield on the 3-month Treasury Bill crossed over the dividend yield of the S&P 500. Again, we will be watching for flows across asset classes if this remains. 

Resilience of growth assets over the past five years is testament to the market taking a longer term view; meaning any short term volatility or risk off flows are being seen as a long term buying opportunity into international markets.

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Commodities

Strong performance in Oil as represented by the ETF OOO up 14.5% this qtr. The surge in oil over the quarter was down to two main events. The first being OPEC’s annual Vienna convention which, despite seeing an agreement to increase oil production over the coming year the organisation released data showing that for the first time in over 5 years OPEC is in shortfall rather than surplus.

The second more WTI specific event was news out of Canada’s Syncrude sand facility which suffered an outage in June which has the potential leave North America 360 kilo barrels of oil a day short. The concern then turned to the Cushing Oil Hub in Oklahoma which was at one point on track for an inventory stockout. This event explains the large spike in WTI in mid-June.

Despite negative performance in Gold ETFs, the metal saw the strongest inflows of the category with $24.3m. Interestingly, one would have assume that risk events such as the US-China trade war, would have been a gold driver. However, what is clear is the risk to the gold price isn’t political (upside risk) its monetary policy tightening (downside risk) from the Federal Reserve, rising real rates are a sign of economy growth and is something that does not require a ‘hedge’ product such as gold.

Figure 25: Funds Under Management ($M)	Figure 26: Geographic Exposure	Figure 27: Flows ($M)
Figure 28: Average Yield	Figure 29: Total Costs	Figure 30: Performance
Figure 31: Average Annual Volatility

Currency

USD was the best performing currency across the category, up 5.5% on average for the qtr. However, USD ETFs also saw largest outflows, -$27.9m. This was largely due to the ETFUSD with $31.41m in outflows. The US performance was down to several factors, first was the collapse in the EUR as the White House levelled threat after threat at the European Union and more specifically Germany. Considering the weighting EURUSD has in the trade weighted USD basket this goes a long way to explaining the increase in the ETF markets. Secondly for the seventh time since December 2015 the US Federal Reverse raised rates and brought forward rate rise expectations for 2018 and 2019 another driver of the USD.

Figure 33: Funds Under Management ($M)	Figure 34: Geographic Exposure	Figure 35: Flows ($M)
Figure 36: Average Yield	Figure 37: Total Costs	Figure 38: Performance
Figure 39: Average Annual Volatility

Figure 40: Currency ETFs

Property & Infrastructure

Reversing last quarters fortunes, Property and Infrastructure ETFs saw positive performance for the June Qtr. Australian and International REITs seeing returns in excess of 8%. Internationally focused ETFs however saw the strongest net inflows at $43.7m. 

Figure 41: Funds Under Management ($M)	Figure 42: Geographic Exposure	Figure 43: Flows ($M)
Figure 44: Average Yield	Figure 45: Total Costs	Figure 46: Performance
Figure 47: Average Annual Volatlity

Figure 48: Property and Infrastructure ETFs

Fixed Income & Cash

A strong June saw HBRD as best performing ETF of the category for the June Qtr, up 1.89%. On the flip side, emerging market bonds were particularly weak with IHEB down 4.13%. We saw strong inflows to Australian Cash and Bond products with greater than $200m in net inflows.

Figure 49: Funds Under Management ($M)	Figure 50: Geographic Exposure	Figure 51: Flows ($M)
Figure 52: Average Yield	Figure 53: Total Costs	Figure 54: Performance
Figure 55: Average Annual Volatlity

Figure 56: Fixed Income and Cash ETFs

Diversified

Strong equity markets saw growth orientated funds as best performing for the June Qtr. This also translated to flows, with growth orientated funds also seeing the majority of net inflows. Multisector ‘Aggressive’, or ‘High Growth’ focused funds account for almost 50% of the category based on FUM. This is not unsurprising as we find most investors tend to gravitate to growth orientated diversified products rather than the more conservative ones.

Figure 49: Funds Under Management ($M)	Figure 50: Geographic Exposure	Figure 51: Flows ($M)
Figure 52: Average Yield	Figure 53: Total Costs	Figure 54: Performance
Figure 55: Average Annual Volatlity

Key Data: Diversified ETFs

Figure 66: Diversified ETFs

Equities

What is also clear from current flows are investors are chasing exposure to the US' economic prosperity. The S&P 500 remains a global bright spot and why we continue to see flows into IVV and InvestSMART’s International Equities Portfolio. One only has to glance at the flows into the USD and USD-denoted ETFs to  reach this conclusion; be it equity, fixed income or commodities exposure, flow is moving into all things US, despite geopolitical risk.

Figure 67: Funds Under Management ($M)	Figure 68: Geographic Exposure	Figure 69: Flows ($M)
Figure 70: Average Yield	Figure 71: Total Costs	Figure 72: Performance
Figure 73: Average Annual Volatlity

We saw generally weak performance across Asia and Emerging Market focused ETFs as China’s two major indices in the Shanghai Composite and Shenzhen Composite fell into bear markets. The reasoning for the collapse in Chinese markets is attributed to the US enacting tariffs on US$50 billion worth of Chinese exports and Beijing ramping up its financial stability programs most notably the debt-to-equity swaps program that impedes return on capital (ROC). Considering the very high valuations in Chinese stocks this impact on ROC impacted overall share value.

It was a mixed bag for flows, with “Equity World Large Blend” seeing strong inflows, again with 50% going to Vanguard, via their MSCI International ETF (VGS) and All-World ex US ETF (VEU) ETFs alone. ‘Equity World Other’ however saw net outflows. This was due in part to iShares decision to close down 5 of their ETFs, IRU, IXP, ISG, IHK & IBK.

Key Data: Equity ETFs

Figure 70: Equity ETFs

Glossary