Exchange-traded funds (ETF): they’re just cheap, simple index trackers that give you exposure to a region, country or theme, aren’t they?
Yes, they can be, and the most popular ones nearly always are. However, it’s only recently Australian investors have begun to understand ETFs can also be used for a much wider range of applications, and have much more intelligent design features, than just gaining simple exposures and selecting companies based on their size alone (commonly known as market capitalisation).
There are two waves of ETFs that have been launched on the Australian Securities Exchange over the past few years that provide investors with a whole range of opportunities to manage their portfolios outside of just pure index tracking. This is a good thing as they are making it simpler for investors to specifically tailor their portfolios to try and achieve outcomes normally only the purview of highly sophisticated investors or professional fund managers.
Firstly, there has been a plethora of smart beta ETFs. These have a fancy United States catchphrase, but, on the whole, are just easy twists on traditional ETFs. Yield ETFs, for example, have a rule set that differs from market capitalisation to try and increase the chance of selecting higher-yielding companies. As you move along the spectrum, you have ETFs that are equally weighted or track factors such as quality, producing very different outcomes to traditional ETFs and allowing investors to tilt their portfolio to an outcome they believe is more likely, for example, taking an exposure to an equally weighted Australian fund will reduce the contribution of banks and resources versus under-represented sectors such as technology. All these types of ETFs provide an alternative to traditional ETFs and can be considered more precise tools for investors to use, yet still follow strict rules as to how to select the companies.
Then we have the second wave of ETFs to be launched that blend active and passive (note – not to be confused with exchange-quoted managed funds, that is, active listed funds, which are completely active) and track sectors/themes that are deemed to benefit from having an active management team decide the pool of companies from which the ETF rules are then applied. The intent behind this more intelligent approach is to avoid potentially buying large sections of the market that may be overvalued by using an investment committee, or group of analysts, to shortlist the best pool of companies that the ETF rules (liquidity, equal weighting and sector representation) can then be applied to. Some of the ETFs covering the technology sector and, even more specifically, the robotics and artificial intelligence sector (considered by many to be the next revolution following the agricultural and industrial ones preceding it) are good examples.
A further example is a recently launched hybrid ETF. Again, this gives exposure to an asset class with built-in diversification (from including multiple issuances) and having an active manager oversee the hybrid selection. The intent is to provide investors with a fund that reduces the risk of holding single issuances, as well as avoiding some of the pitfalls a strict rules-based methodology may encounter.
This challenges many investors’ preconceptions of ETFs as this looks and feels very similar to a traditional active fund, but with additional benefits, namely heightened transparency as to the strategy, the constituents and intraday pricing.
Kris Walesby is chief executive of ETF Securities.
