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Busting the myths on ETFs

  • May 29 2018
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Busting the myths on ETFs

By Lucy Dean
May 29 2018

ETFs have been treated like “pariahs” but that’s neither fair, nor true, the CEO of ETF Securities Australia has said, while dispelling myths surrounding the growing investment vehicle class.

Busting the myths on ETFs

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  • May 29 2018
  • Share

ETFs have been treated like “pariahs” but that’s neither fair, nor true, the CEO of ETF Securities Australia has said, while dispelling myths surrounding the growing investment vehicle class.

Busting the myths on ETFs

Speaking on the Nest Egg podcast, ETF Securities Australia’s Kris Walesby said criticisms of ETFs as driving the market in certain directions are unfounded as ETFs, by nature, track.

“ETFs cover a lot of different things. If a product provider's provided something that is on a highly volatile product and then you've tripled it, whether that ETF should be there or not is a separate discussion, but the ETF actually did exactly what it was meant to do,” Mr Walesby said.

“People are resentful because they've lost their money, but actually, it's not the fault of the ETF.”

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He also spoke to the team about:

Busting the myths on ETFs

· Why there’s no reason to be scared of ETFs;
· Choosing between active and passive managers; and
· Why being able to trade an ETF during the day is an “amazing risk mitigation factor”.

Thanks Kris, for sharing your insights with the Nest Egg podcast team!

You can stay up-to-date with what Kris Walesby and ETF Securities Australia are up to here.

Have an investment story to share? Get in touch at This email address is being protected from spambots. You need JavaScript enabled to view it. and you might get featured on the next episode.

 

David: Good day everyone. Welcome to the Nest Egg podcast. David here. I'm joined today with our guest, an expert, Kris Walesby. Kris is CEO at ETF Securities Australia. Kris, welcome to the show.

Kris: Hi David.

David: It's the first time that we've had you on here, but we've also had Kanish previously, and I've just recapped that podcast. Kanish was covering a lot around robo tech, a lot of the new things that are in the investment space as a whole. I think this will be quite nice to bring it back to the ETF product, the ETF market, the ETF cycle in a whole. I think you're the man to give us the insight. Before we do, I'd love to hear a bit more about where you've come from, your background, your expertise, and how you've become CEO of ETF Australia.

Kris: Yes. Briefly, I for about five to ten years, like a lot of 20 year olds did, just bounced around different jobs, not really sure what I wanted to do, and then I was actually at Deutsche Bank in Australia and realised I wanted to do a client-facing role.

I went back to England, did a masters in finance, and then joined this company called iShares, which I actually had no idea what it was at the time, and I got in there 2006, late 2006, 2007 before the GFC. Even though that was a hairy time, even for iShares there, subsequent to that, ETF became the fund of the product type that lots and lots of investors swarmed to, hence iShare's success now. Everything after that, I guess it's partly to do with my skill but partly to do with the fact that ETF is more popular. I eventually came to work for ETF Securities here.

David: No, awesome. You must have been pinching yourself when you realised in terms of what this investment product or this investment asset is all about, because back then, I think it was very new. It was the shiny toy in the investment process, and now ETFs are a real juggernaut in that cycle, so we're looking at, I know yourself recently, ETF Australia, recently just clocked over one billion funds on the management mark, which is fantastic. I think that's probably going to be going up more and more over the years to come with the amount of growth in this space.

Kris: Yes.

David: I know that there's always, and I've said this before, there's a huge potential in what I see as just a personal opinion within the ETF market, but I think you'll be able to highlight a little bit more about what that growth is at the moment. I'd like to know a bit about where the life cycle of an ETF is today, so are we still in the infancy stage, or are we well into this market? Is this something which is really going to bolster from here on?

Kris: Yes. You're absolutely right. The ETFs back in the day, 2006, 2007, they were definitely growing, but no one really knew that they were going to benefit so much from the aftermath of the GFC where compliance officers and risk officers were mandating clients who previously used not bad products, but more opaque products. They were now mandating them to use ETFs because they're transparent, et cetera. That's kick started a whole world of funds under management that's moved into passive, some into ETFs, some into passive mandates.

In Australia specifically, I think that where we are now is at the very beginning of what I call rapid adoption. A lot of the early learning, which happened equivalently in Europe in the mid 2000s and through the GFC, is happening and has happened here. There are still a lot of people who don't know what ETFs are. It's not like America where everyone knows what ETFs are, but most of the clients we talk to now, we're not having to talk to them about what is an ETF, how does it work, et cetera, et cetera. Because of that, people are much more now either dipping their toes or have dipped their toes in ETFs for some time.

With that, you get this very rapid adoption, and you see that in all the different markets that use ETFs where it almost goes from inertia and people still wavering to actually we're all in. With that all in, I don't mean they put everything into ETFs, but they suddenly don't become nervous anymore and see it as the product of choice, and then begin to use it across the board.

David: Yes, of course. Going back to that as well, there are a lot of people, especially in Australia, which because this still is relevantly a new initiative ... Just to roll back, if you haven't caught up with our last podcast or you haven't had a chance to look at the blogs or insights that are on our website from ETF Securities Australia, ETFs in general are exchange traded funds.

These are essentially investment instruments that can be traded on a stock exchange such as the ASX, but it would be either the index or it could be managed as a fund actively. There's a few different options there, but is there anything else which is really obvious in the ETF space that you could just explain for our listeners?

Kris: Yes, absolutely. It is true, a wider level to what you're saying, that there's still, as we said before, many people who don't understand ETFs, so really what I was talking about before with the rapid adoption is mainly more intermediaries, stock brokers. Probably most of your audience are still very new to ETFs.

To answer your question, the main thing that I always think about ETFs is it's not that complicated. It's a fund that trades on exchange. Unfortunately, anything with an acronym, like ETF, frightens people. Really, there's nothing to be frightened of. The main thing is rather than having to wait until the end of the day or two or three days later to get your order back for your fund, you can actually trade it during market hours.

Now, that makes it feel like a stock, and sometimes it scares people because they're not used to doing that with their fund, but really it's just a cheap, easy way to get access to a theme or an index, as you say. They're mainly index trackers, but there are some active ones, without having to overthink it. That's really the best way to think about an ETF is on the whole, they're simple ways to achieve an objective without taking a lot of risk, without paying a lot of money.

David: Yes, 100 per cent. Bang on. I want to talk a bit more around how ETFs are created and how they represent different parts of the market in a bit, but just in terms of your day to day role, what common questions come up from investors or even advisors, people that are speaking to you directly? What are they thinking about ETFs in this space right now today?

Kris: I guess the biggest problematic question is they'll say something like, "Kris, there are so many ETFs. How do I choose one?" That's a pretty fair question. There's 150 plus ETFs, depending on how you count them, what you include in that. It's difficult to know which one does what.

That's why we brought out, which I know Kanish has talked about the ETF landscape to try and help investors, be they intermediaries like brokers and advisors, or investors that you have, that you're talking to, to try and help people navigate through that. People are confused around the number of ETFs, but I always think about this is real money, your money that you're putting down. If you go out and buy a car for $20000, you look at the different cars that are available. You really, really think about it, and then you go and purchase the car, and you know that $20000 means a lot to you.

Unfortunately, when people look at funds, they don't seem to be as sensitive to the fact that they're parting with exactly the same amount of money, and they do a lot less research, and bear in mind, a car depreciates. The fund, you're trying to make go up in value, so we would say to look into what the different funds do and don't be overwhelmed by the amount of ETFs because you can always go to a provider and ask the questions. That's something that we don't get enough of as providers, not just ETF Securities, but all the providers. We've got hotlines. We're desperate for people to call us so that we can help them, not just in our products, but to understand ETFs more.

I guess the other thing that people are confused about is trading, because most Australians are used to buying funds by just putting in an order on a platform and they close their eyes, two days later, they get it, right? When it's trading on exchange, they don't understand how it's being priced, are they being ripped off, et cetera, et cetera.

Again, and this is definitely too technical for this particular conversation, but we can probably have it for a more advanced conversation if you want to, but almost all ETFs trade at fair value because there's something called open-ended. It just means that if they start to go above fair value, so they go to a premium or a discount, there are mechanisms to make sure it's brought back in line. A lot of people don't trust it because it feels new, but actually on the whole, it works perfectly. It's just like trading a stock.

David: Yes, for sure. That's a huge point, as well. ETF education is something which we boast about quite a lot over at Nest Egg. It is really not just on ETFs, but across any investment instrument. Educate yourself on what you want to get involved in, and it becomes more English to you. You're more confident as an investor to get involved.

One thing which I do highlight as well in this space is that ETFs in particular, because there is so much variety and the menu is reams and reams and reams long, but there's so much education out there to go with it. Like you said, there's plenty of options to get involved on the content that you put out there in this space, and you consistently put this out here on Nest Egg, as well.

The good thing about that, then, is the fact that there's a lot of was to diversify. There's a lot of ways to get involved in that fund. I know that it's relatively taking off at the moment, but going back to your original point around the GFC, some people feel this investment instrument hasn't really been around pre-GFC, so they think, "Well, how's it going to test itself in a market downturn?" Does anyone really know how that could work at the moment?

Kris: Well, I was in it during that period, so I would say with the exception of high yield corporate buns, and again, even those ETFs worked really, really well, but there's very technical reasons why it looked for a period like they weren't working very well. That's not for today, but all the other ETFs worked perfectly in that situation.

Everyone who's listening, they need to understand that an ETF is really just wrapping the underlying securities, be they stocks, be they fixed income. In a situation like GFC when everyone was selling everything, you expected the ETF to be down 5 per cent on the day before or even more, you expect it to be wide, so that's the buy price and the sell price. You expected them to be wide, I.E. expensive, because there was so much volatility in the market that no one really knows what the price is and they're protecting themselves against this and it's a wall of money trying to sell.

David: Yes.

Kris: In that situation, you expect the ETF to do exactly what the underlying did, and in almost all examples, the ETF did. One other thing about that is that because most people haven't gone through financial crisis holding ETFs, what they don't realise is that being able to trade an ETF during the day is an amazing risk mitigation factor that people haven't had to think about because with a normal mutual fund, and I've got nothing against them, but you would put in a redemption order or a settle order. You could wait two or three days, we already discussed that, to get filled. In the meantime, the market could be down 20 per cent. At least with an ETF, even though you've lost 5 per cent on the day, at least you can sell it there and then.

David: It's liquid.

Kris: Yes, and walk away.

David: Yes.

Kris: No one really thinks about that, and I can tell you that the clients who are ringing us up during a credit crisis, absolutely delighted to take a 10 per cent loss and leave rather than have to wait 25 per cent down to get out, and also with a lot of these funds, especially the hedge funds, they were gated, so gated for your ordinances when the fund is actually closed for sales. You can actually get your money out. ETFs basically do exactly what's in the underlying GFC. They were negative, but then everything was, and so I think it did exactly what they were meant to do.

David: Yes, no, I think that's a great way to explain it. That, coming back to it as well, ETFs don't just look at new initiatives. There's a lot of sought after markets here, which they do get involved in. They have been tracking investments that have been around for tens, hundreds of years. We're talking about the S&P or we're talking about others. There's been data collected from those investment cycles, which can be very much implemented into an ETF, because like you said, it's almost wrapped around it.

That brings me onto a bit more around the pros around new business, new opportunities, new ways to diversify, and new revenue streams for investors, is there's a lot of sought after markets such as unlisted businesses. I know that we've already discussed a bit more around the mega trends, such as robo tech, AI, and all this exciting upcoming stuff which investors are very interested in. It does raise a lot of questions and likewise just a lot more time to educate yourself. What are the most exciting things in that space that ETFs are giving investors access to?

Kris: Yes. The one thing about ETFs is it's one broad name for lots of different things. To your point, David, they began with what we call vanilla ETFs, which means very basic ETFs, tracking the ASX 200 or the S&P 500, et cetera, et cetera. It's almost like medicine. You can be a general practitioner. You can be an orthopaedic doctor. You can be a brain surgeon. They're all called doctors, but they all do different things. They're all different levels of the spectrum, and that's what's happened with ETFs. You've got the plain vanilla ones, and they will always be the biggest ETFs because they provide an easy way to achieve a basic investment solution.

The more exciting ones, you've already talked about mega trends, so I'll leave that alone, but what I like, especially in the Australian environment, is the selection of Aussie equity, yield ETFs. What we see a lot of is SMSF holders who have five or six Australian companies in their portfolio, mainly banks.

David: We know what they are, yes.

Kris: Yes, exactly, Telstra. It's so dangerous, because even though those companies have given a lot back to investors over time, and I can't deny that, and there's also the franking credits, which is an amazing thing in Australia, but any portfolio that's got less than 30 stocks is factually, mathematically undiversified. It gives a lot of risk there.

Now, what I think is a better way to play it is if investors buy probably always two of the available yield ETFs on Australia, because that way they're getting 30 to 40 stocks in each ETF with just one purchase. You've got a broad range of high yielding stocks and you don't have to do the rebalancing, so if banks are out of favour, that's rebalanced out for you.

The reason why I say two is because the yield ETFs have different strategies, and you don't know which strategy is going to work.

Getting around to your point of why it's exciting, I think it's exciting because it takes away a lot of the risk. There's still risk, but it takes away a massive amount of investment risk from investors in Australia who are very concentrated, and it still allows them to properly plan to retire or to even make sure that they can live in their retirement by getting the yield from the ETFs.

There's many other different things, but I think the one that really resonates and goes to the heart of Australia and Australian accumulation phase and retiree investors is yield ETFs and the fact that it can take a lot of the angst over having to take risk in your portfolio away.

David: Especially, right, in a volatile market as well, it's kind of one of those things where keeping yourself diversified, and it can be really expensive to pick 30 stocks. It's expensive to do that. It's a cost effective way essentially to get access to it.

Focusing on Australia and the domestic side of things is very popular. As you can imagine, that's the staples of a lot of Aussie portfolios today. I think a lot of people are looking at ways to branch to more international objectives, and there's also the case that when you're on the stock market, for example, you might not have such a selection or the opportunity to get involved in international business. That's one thing which ETFs could also help in that space, as well. Is that correct?

Kris: Yes. One of the biggest areas of growth is international. That is exactly to your point, so as Australian investors get more and more savvy in some of the traditional ways, we've already talked about the stocks, or they were just given an advisor and the advisor wasn't educated themselves as to what to do, everything would look Australian. ETFs gave it a really easy way to both types of people, advisors or investors doing it themselves, to suddenly be able to go, "Actually, I genuinely think America's going to do well, but I don't know which stock in America is going to do well, nor will I ever, and plus the fact I'm asleep when a lot of the things are going on, so I'm just going to get a diversified fund and on balance, hope that America as a whole goes up."

Since then, you've got a lot of different ways to play it, so there's the very basic way where they're just big, global funds. We call them global funds. They've got a little bit of each country in them, then you can play specific regions, like we already talked about the S&P 500. We came out recently with one that's just on the Euro zone in Europe because a lot of Australian investors were concerned about Brexit and what effect the UK would have on the rest of Europe. The ticket code for that is ESTX.

You become a bit more finessed and you allow people to be much more specific if they want to be. One of our competitors has got a career fund, for example, so with the unification of career, that's gone up a lot. People have got the ability to take very specific things.

On the whole, to your point, international is something that all Australian investors should look at because even though Australia has got this very high yield culture, you do need to make sure that you're looking at opportunities overseas because that's the other 98 per cent of the world.

If you really want to make sure that your portfolio has got that ability to weather lots of different types of basically negative periods when they come, you need to make sure that you've got other things that aren't just Australian in there to make sure that you're diversified, as we spoke about before.

David: Yes. That's exactly right. I think Australians do like to swim in the same pool, and I think that's not always a bad thing, but to cast the net out a little bit broader and wider, there's opportunities out there. Like you said, 98 per cent of it is probably unexplored by most Australian investors until now, until they can get access to it. There's obviously a lot of opportunity in that space, too.

I know that there's a bit of a debate going on around a couple of things. People label ETFs around active or passive. There's two different differentiations there. I'll let you explain a bit more about what those two themes are, but is that a choice? Is this something which you don't have to be on one side of active or passive, do you?

Kris: Yes. You raised this before. ETFs are mainly tracking indexes, so they're basically tracking a set of rules that other people provide. That's the case for ETF Securities, but there are active ETFs, as well, so very well-known Australian names like Magellan and Platinum have brought out their active ETFs on their traditional managed funds.
My main point isn't so much about those. It's more about this active versus passive debate. Which is better? Do you take an active manager, which has been a mainstay until about five years ago. It's been a mainstay of Australia and not just Australia. It's also across the world, or do you take passive, and that's normally for anyone but big institutions through an ETF? Which is better? Am I doing something stupid if I take an ETF, or am I making a mistake if I take an active?

I hear this all the time. My general view, and it's a very basic and easy rule, is that you should take an active manager if you think that she or he is very likely to outperform the market that they're either tracking, or if they're something called an absolute return fund, which means that they're not tracking anything, but if you think that they're going to provide you a really, really good return, then you should, because you would be stupid not to. If you think that they're able to beat the market, which is what the index is, then you should pay more because they're intellectually and practically able to beat the market, and there's a premium for it, right?

If you're not sure or you can see case evidence that there's not persistent history of outperforming the market for that particular fund manager, then I would say that it's not necessarily the smartest move because on the whole, it's difficult to beat the odds and the market, it's like a casino in the fact that the house always wins, right? The market is the market and you'll always have slightly more losers than winners because there's transaction costs, as well. It should be a 50/50 split, but it's not. It's more like 55/45 in favour of the index.

Unless you really think that that person is going to beat the market, then you should be also incorporating passive funds in there as well and blend them, and that's probably the same for direct securities, as well. If you really think the commonwealth bank is going to do 20 per cent in the year, you'd be stupid not to, but if you don't and you don't really have a strong view on any of the banks, then it's better to take an ETF that tracks the banks because you're not really sure either way. It's more just to demystify that particular issue because everyone talks about two camps, when actually most people, it should be a blend, depending on your view.

David: No, absolutely. Look, this has been really helpful to understand just the whole broader market, what we've been discussing here. I want to finish off with, I'm going to ask you to bust a bit of a myth. This is something which is not just rumours or stories, but this is something which people, maybe especially investors, feel a little bit nervous about in the ETF market, that it may have a negative trend on the market itself. What are your thoughts on that?

Kris: This has come about because people hear in the press and there's lots of mainly active managers that write about the fact that because the ETF market is so big, especially in America, they're normally talking about America where it's about anywhere from 20 per cent to 35 per cent of trading per day on all of the American exchanges collectively is ETF-based, right? People are saying, "Well, you can see that the ETFs are sold off heavily, and therefore because the ETFs are sold off heavily, the underlying stock's sold off heavily, and therefore the ETF drove the market rather than the other way around," right?

There may be isolated cases where that's the case, but in 99.9 per cent of the time, and it goes back to what we were talking about 10 minutes ago, is that the ETF is driven by the underlying stocks or bonds in the market, and it's actually the stocks that are being sold off and the ETF has to follow, not the other way around, right? The ETF is the proxy, and everyone can see it. It's almost because you can see it's traded on exchange, and therefore you can pin a badge on it and say, "It's your fault."

Actually, let's even look at the stats. Let's just say it's 25 per cent of ETF trading. The other 75 per cent is by everyone else. It could be an institution selling down some stock to buy something else. It could be retail investors selling their securities out of the 401Ks, which is the SMSF equivalents in America. It could be a fund manager deciding that they no longer want a position.

75 per cent of the market is doing something that we can't see. That's much more likely to be driving the market than the 25 per cent of the ETFs. I just think that ETFs are being a bit of the pariah at the moment because people can say, "Well, we can see it, and therefore it's their fault," when what they can't see is what's driving the other 75 per cent of the market.

Also, the other thing is, some of the ETFs, particularly, they're in focus, like these ETFs. We don't have any like this in Australia, but they will track something like, for example, the VIX, which is the biggest volatility indicator in America. When the volatility picks up, this can go say from 10 to 40 in one day, and you have an ETF, or it's called an exchanged traded note, but like an ETF, that tracks the VIX but three times leveraged. That's what it's doing. It's giving people who have invested in it three times the return of that particular-

David: It's like an evolved version.

Kris: Yes. It's like a hyper VIX, right? You get what we call long ones, ones that if it goes up in value, you get three times the value, and if it goes down, you get three times negative the value, right? If something jumps by 35 per cent, you're going to get wiped out on that because you basically lost all your money in one move. Is that the ETF's fault when the ETF is doing exactly what it was meant to do?

David: Yes.

Kris: That's the other issue is there are, as I said before, ETFs cover a lot of different things. If a product provider's provided something that is on a highly volatile product and then you've tripled it, whether that ETF should be there or not is a separate discussion, but the ETF actually did exactly what it was meant to do. People are resentful because they've lost their money, but actually, it's not the fault of the ETF.

David: It's almost the case of that whole monkey see, monkey do. It's ETF see, ETF do.

Kris: Yes.

David: I think that's probably exactly what would reflect on there instead. Kris, this has been great. I've enjoyed listening to you and your insights and your philosophy around the market. If there's anyone out there who's counting the amount of times you've said the word ETFs, congratulations. I'd love to hear a number.

Also, as well, there's heaps of information across from ETF Securities Australia on Nest Egg already, but we do intend to populate that with more education, more news, and a lot more insights from Kris, Kanish, and the team as well.

Thank you very much for listening. If you have a story yourself that you want to get in touch with, it is This email address is being protected from spambots. You need JavaScript enabled to view it.. You can also catch us on LinkedIn, Facebook, and all the other social media platforms. Kris, thank you very much for coming on the show.

Kris: Thanks David.

David: Cheers.

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