Goodbye active funds as ETFs approach record levels

Money keeps flowing into exchange traded funds and away from active managers. Here’s the new ETFs and how some of the most popular performed.

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Australia’s booming exchange-traded fund industry could set a record $150bn in funds under management by the end of the year, as investors ditch active managers in favour of the low-cost, easy-to-use index trackers.

Indeed, a third of Australian investors now use exchange traded funds as the core of their portfolio, up from just 4 per cent in 2019, according to local ETF provider Betashares.

And why not? Active managers have hardly proved their worth in recent years.

The latest annual Mercer Investment tables, released this week, show the median active fund returned just 0.1 per cent for the year ended December 2022 – that’s before management fees.

Even long-short hedge funds only managed to eke out a 1 per cent return, again before fees.

The ASX 200 benchmark fared slightly worse, with a negative 1.1 per cent return, which is the kind of return you would have gotten from an ETF tracking the top 200 listed companies.

But when you factor in the much higher fees charged by the so-called smart money, there’s little incentive to choose active over passive.

Australian investors are pouring into these index trackers, more so in the local market than globally.

Betashares, the second largest ETF provider in the country, saw $4.4bn flow into Australian equities ETFs through 2022, which was well above the $3.3bn that went into international equities.

This marked a big turnaround from 2021, when Australian investors pumped $11.8bn into global equity ETFs and $5.5bn into Aussie shares.

All up, the local ETF industry received $13.5bn of net inflows last year, right as the unlisted funds sector suffered its worst year on record with a monster $26.8bn of net outflows.

Vanguard’s Australian and international equities ETFs were the most popular among investors, followed by Betashares’ top 200 Aussie ETF and VanEck’s QUAL, which invests in quality global companies, excluding Australia.

But thematic ETFs are increasingly capturing investors’ attention. From climate change, to technology, to food, thematic ETFs provide exposure to the hottest trends.

Some of 2022’s most popular thematics, including battery technology and cybersecurity, stand a good chance of gaining further momentum this year.

Betashares chief executive Alex Vynokur.

For others, such as crypto-linked equities, the outlook is much less clear. ETFs were somehow among both the best and worst last year: while they proved popular with thematic investors driving strong net inflows through 2022, the digital currencies themselves – and the linked ETFs – plunged in value.

Just look at the Crypto Innovators ETF (CRYP), which pulled in strong flows throughout 2022 despite its share price collapsing more than 80 per cent. It debuted in November 2021 above $11 right as the crypto market started to implode, and hit a low of $1.36 in December making it the worst-performing ETF in the local market for the year.

As the stock recovers – it’s up 58 per cent year to date – it’s unclear if investors will stay in for the long haul or try to get some money back while they can.

The China trade, meanwhile, has been a hot favourite in the first weeks of 2023.

Betashares’ Asian Technology Tigers ETF (ASX: ASIA) last month received its first inflows since May 2022 – and, at $11.6m, the largest inflows since August 2021. Funds under management at the ETF have also just bounced back over $500m for the first time in a year.

Likewise, AI-focused ETFs, such as Betashares’Robotics and Artificial Intelligence ETF (RBTZ) or Nasdaq-listed Global X Robotics & Artificial Intelligence ETF (BOTZ) – both among the dogs of 2022 – have had strong gains so far this year as the rise of chatbot ChatGPT captures investors’ imaginations: RBTZ is up 14 per cent since the start of January while BOTZ has gained 19 per cent.

ETFs more broadly are once again expected to benefit from the funds leaving active managers this year. But it’s not just retail investors choosing passive over active; financial advisers are increasingly choosing passive index trackers for clients.

“ETFs continue to tear away from the traditional unlisted managed funds as a vehicle of choice. We have seen that in both strong market conditions and in the more uncertain market conditions over the course of 2022,” Betashares founder and chief executive Alex Vynokur said.

“They‘re also becoming the preferred way for financial advisers to invest when looking after client money. That is very clear.”

For Rory Tobin, head of State Street Global Advisors’ Global SPDR ETF Business, the big appeal of ETFs is their ability to democratise investing, “giving investors large and small access to institutional-grade solutions that offer efficient, cost-effective exposures to all corners of the global investment market.”

New ETFs, meanwhile, are constantly in the pipeline. Just this week, ETF provider Global X launched Australia’s first ASX 200 passive covered call ETF (AYLD), which tracks the ASX BuyWrite Index.

A covered call, also known as a buy-write, involves selling call options over stocks an investor already owns, while generating an income in the form of a premium.

Blair Hannon, head of investment strategy at Global X, said the ETF would help investors balance portfolio growth and income.

“We consistently hear how important income is to investors across all age groups. We see options strategies, incorporated in ETFs, as a great entry point for investors to supplement existing income sources like dividends or coupons from bonds, he said.

“Used as a core equity holding, the options premiums of a covered call ETF can smooth the impact of market falls. In this way, it provides investors with potential protection against drawdowns. ”