ETF criticism unfounded

06-Sep-2017

By Daniel Paperny

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Recent industry criticism of exchange-traded funds (ETF) was a symptom of active managers feeling increasingly threatened and overlooked the complexity of the passive versus active debate, according to Stockspot.

Speaking with financialobserver, Stockspot founder and chief executive Chris Brycki noted the groundswell behind ETFs had been due to growing awareness of the benefits of low-cost investing among Australian investors, as well as a shift away from active management.

Brycki said it was simplistic to label ETF investors as being uninformed about how the funds worked, given active managers had historically had their own difficulties identifying quality companies.

“If stock picking was as easy as selecting the 'quality' companies, professional fund managers would simply avoid all underperforming stocks and consistently beat the market over the long run,” Brycki said.

“That doesn't happen because for every poor-performing company they avoid, they also miss a winner.”

He said active managers were increasingly feeling the heat because a low-fee, market-cap-weighted index “outperforms 75 per cent of active managers after costs on any given year” and that was becoming particularly pronounced in a climate of low growth and low returns.

“The majority of market returns come from a tiny number of winning outliers [and] if you're missing one of those stocks from your portfolio, you're doomed, regardless of how many losing stocks you've avoided,” he said.

A significant concern for ETF investors overseas has been the risk associated with synthetic ETFs that use derivatives to replicate the market performance of a benchmark.

While synthetic ETFs can provide investors with reduced tracking error before fees and taxes by being more closely aligned with the value of their underlying investments, investors take on credit risk associated with the ETF derivative counterparty.

Brycki said despite being in their infancy in Australia, it was important for investors buying those ETFs to be aware of the additional risks involved.

“There are very few synthetic ETFs in Australia and under ASX rules they need to be labelled as such,” he noted.

“That said, for some assets like oil it's not viable to create a physically backed ETF so [investors] wanting to invest in these assets will always need to take [on] some counterparty risk.”

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