Exchange traded funds boom amid turmoil: investors told to take care

Money is still pouring into exchange traded funds despite volatile markets, and investors are urged to understand how they work.

Exchange traded funds are attracting hundreds of millions of dollars of new investment money each week despite shaky global financial markets.

However, ETF returns have differed dramatically in performance over the past year – reflecting global trends such as booming energy prices, commodity shortages, tech stock troubles and collapsing cryptocurrency prices.

The latest data from ETF Securities shows $1.63 billion of inflows into the sector in the past four weeks, compared with $641 million of outflows, while online investment group Stockspot says Australia’s ETF market has doubled in size in two years to $135 billion.

“We expect the growth to continue as Australians are rapidly embracing the benefits of low-cost passive investing, with more money coming out of actively managed funds into the lower cost, index tracking funds,” said Stockspot senior manager of investments and business initiatives Marc Jocum.

ETFs spread investors money across all stocks in an index – such as the ASX200 or S&P500 – to provide broad diversification, but have increasingly expanded into thematic or sector-specific products.

“ETFs have grown four times faster than the broader Australian wealth management market, showing that ETFs are capturing a growing share of investable assets in Australia,” Mr Jocum said.

Catapult Wealth director Tony Catt said his firm used ETFs for clients’ international investments “for diversification, simplicity and liquidity”.

He expected the sector to continue growing through the current volatility in financial markets.

Mr Catt said volatility often prompted investors to become more conservative “and go back to principles that have never been wrong – diversification and playing a bit safer”.

However, ETFs can also be risky and bite investors hard. An analysis by Stockspot of the winners and losers of the past 12 months shows total returns from some technology and Asia-focused ETFs have been between negative-20 and negative-40 per cent.

Cryptocurrency-focused ETFs are newcomers and have been caught in the recent crypto downturn. One fund (CRYP) attracted huge interest when it launched in November but its unit price has dropped from $11 to just above $3. New crypto funds launched this month and their trading volumes are less than 10 per cent of CRYP’s.

Stockspot’s Marc Jocum says ETFs holding complex derivatives can be dangerous.

Other ETFs have boomed in the past year, especially those focused on energy, resources, agriculture, cybersecurity and India.

“Inflationary pressures caused by loose monetary policy, the war in Ukraine and global supply chain issues have led to rising commodity prices such as oil, nickel and agricultural goods like wheat,” Mr Jocum said.

“The best performer was the BetaShares Crude Oil Index ETF-Currency Hedged Synthetic (OOO), which is up over 77 per cent over the past year.

“Notwithstanding good one-year returns, this ETF has seen its price fall nearly 50 per cent over the last five years. This is despite the price of oil rising over 100 per cent in the same period.”

The divergence highlighted the dangers of synthetic ETFs that held complex derivatives instead of the underlying investment, Mr Jocum said.

“For example, the ETFS Physical Gold ETF (GOLD) holds physical gold in a vault in London, whereas OOO is made up of financial derivatives instead and doesn’t actually hold any physical oil,” he said.

Stockspot holds broad index-based ETFs, but investor interest has driven the launch of thematic ETFs with quirky stock codes such as ACDC (battery tech), ROBO (AI and robotics), HACK (cybersecurity) and CURE (biotech companies).

Technology-focused ETFs have taken a beating in the past year.

More than 45 ETFs have launched in the past year alone, and there are now almost 250 available on the ASX.

ETF Securities head of distribution Kanish Chugh said he expected more growth in new investors and investment options.

“Investors have got choice,” Mr Chugh said.

For example, while East Asia and Europe-focused ETFs are in negative territory over the past year, the ETFS-NAM India Nifty 50 ETF is up 21 per cent.

“India has had a stellar 12 months,” Mr Chugh said.

“They came out of that second wave of Covid in April last year and hit the ground running.”

Mr Chugh said India had been described as being in a “super bull cycle” and 54 per cent of its Nifty Fifty index was focused on consumption, with 70 per cent focused on domestic earnings.

“We have also seen a lot of flows into our gold fund.”