Making smart traders smarter

How to avoid the ETF Trap

13th September 2017
How to avoid the ETF Trap
Arnie Selvarajah
Chief Executive Officer
Bell Direct

This article was first published on Investor Daily here.

ETFs allow investors to gain easy access to a wider range of investments at a relatively low cost. With one simple transaction, one can, for instance, gain access to every single stock in the ASX 200 index.

ETFs also give retail investors the opportunity to access asset classes that were previously only available to institutional investors, such as fixed-income products and emerging market equities.

The explosion of ETFs is a global phenomena. Since their introduction only two decades ago, exchange traded products now total around $5 trillion, with the US accounting for more than 70 per cent of global assets under management.

The range of assets investors can access through ETFs is expanding as the market matures and becomes more competitive, which is contributing to the growing appetite for the products.

The first Australian ETFs, which came to market in 2001, were all invested in Australian equities. Now more than 40 per cent of exchange traded products are offering exposure to overseas markets. As competition in the market has increased, new market segments and asset classes have also been introduced, including property, infrastructure, currency, commodities and smart beta.

More broadly, the growth of the ETF market reflects a dramatic shift in customer demand for simplicity and low cost.

Growing dissatisfaction with high fees among traditional fund managers, and a rising awareness of the poor track record some active managers have achieved when trying to beat their benchmarks, has helped spur growth in the ETF market.

Australian ETFs have generally replicated their investment benchmarks closely, with only minor deviations, however investment in ETFs is not without risks. An emerging issue we are seeing is an overexposure to overtly-similar passive strategies, leaving investors poorly diversified, and putting their portfolio performance at risk. For every eight stocks a self-directed investor owns, at least one of these stocks is an ETF, if not more.

Unquestioned allocation to ETFs is a common trap among uninformed investors. This is a concern because, for most investors, passive investment alone won’t achieve their desired outcomes. Time and time again we are seeing the need for an element of active management.

Careful attention must also be given to the different styles and exposures of various ETF products. All ETFs are not created equal.

Until recently there have been no tools in the market to help investors discern the differences between various products available. That’s why at Bell Direct we have launched an ETF Filter, complementing our existing mFund Filter, which helps investors choose which managed funds to invest in. The functionally enables investors to simply compare performance, fees, asset class, sector, issuer and indirect cost ratio (ICR).

There are now more than 200 exchange traded products trading on the ASX (compared to around 50 products in 2011), which is an unrealistic number for the average retail investor to compare. The filter eliminates a pain-point for investors and supports portfolio diversification.

The trend towards actively-managed and smart-beta ETFs is just another reason why investors need tools to simply compare products. The world of investing is continually innovating and changing, and today’s investor needs to be able to make smarter investment decisions

Demand for ETFs is likely to continue to grow as more investors become familiar with them. Investors should be careful where they allocate their funds in the ETF universe.