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Is ETF industry growth causing market distortions?

ETF, exchange-traded fund, active management, actively managed fund, investment strategy, passive investments, BetaShares, David Bassanese, David Pace, Greencape Capital

Australia’s ETF industry continues to grow rapidly but an active fund manager has suggested this growth may represent a new opportunity for active managers to outperform.

July saw an additional $688.4 million invested in to Australia’s ETF sector, which according to ETF provider BetaShares, brings the volume of funds managed by the industry to a “record high” of $30.1 billion.

In its monthly ETF sector review for July, BetaShares noted that all of this growth came from new money being invested into these funds as the Australian share market remained flat over the same period of time.

“Hitting the $30 billion milestone is a significant achievement for the Australian ETF industry and an unequivocal sign of investors’ strong adoption and understanding of ETF products,” said Alex Vynokur, the company’s managing director.

“The size of the industry today also reflects the value that ETFs have delivered to investors in Australia, in terms of ease of access to all major asset classes, convenience and product transparency.”

However, the continued movement of money into passive investment strategies like ETFs could, according to David Pace, cause distortions in the market.

Mr Pace, a portfolio manager for investment firm Greencape Capital, said the increasing flow of money into such products “creates liquidity and pricing abnormalities” which in turn create opportunities for active managers.

“With the index already highly concentrated, passive funds continue to pour in, directing more capital into companies based on their position within the index, regardless of their underlying fundamentals,” he said.

“We see this as an inefficient allocation of capital that creates pricing abnormalities and provides significant investment opportunities for active managers. The opportunities for active stock pickers to capitalise on mispriced companies are greater than ever.”

Mr Pace nevertheless warned that “a willingness to deviate from the index does not alone result in success” and that active investors will need to conduct adequate analysis and to ensure they’re achieving suitable risk-adjusted returns.

Is ETF industry growth causing market distortions?
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