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ASIC gives ETFs the thumbs up

ETF Watch - Sep 12, 2018

In a few short years the Australian ETF market has moved from the fringes to the mainstream, now boasting over $40 billion in assets and over 30% per annum growth. Recognising this growth, the corporate regulator the Australian Securities & Investments Commission (ASIC) recently ran a review of the segment, as part of their role of maintaining performance and promoting confidence of the financial system.

The good news for investors, is the ASIC report showed the Australian ETF market is performing reasonably well and ASIC found no major concerns. It is certainly faring much better than those being targeted under the Banking Royal Commission at the moment. ASIC did highlight some areas for improvement however, which we’ll touch on below.

We’ll spare our readers the 59 pages of the report, although it can be downloaded here for anyone interested. Below is a brief summary of ASIC’s findings.

What was the purpose of the ASIC review?

ASIC state their review had two purposes:

  1. To check whether the perceptions about Exchange Traded Products (ETPs) are consistent with how they are operating; and
  2. To examine how well ETPs are operating in Australia, especially in relation to their distinctive features.

ASIC’s report focused on both passively managed ETFs and funds actively managed ETFs, also known as Exchange Traded Managed Funds.

ASIC’s Key Findings

The review found that the Australian ETF market is generally functioning well and delivering on its promises to investors.

Generally, ETF trading is liquid, with narrow bid-offer spreads (ASIC found the spread to be 0.06% or less 50% of the time), meaning ETFs can be purchased on the ASX close to their underlying Net Asset Value. However this does not always apply to all products at all times, with ASIC observing spreads temporarily widening at some times. We’ve had the same observations, particularly at times of market distress and for asset classes that may not be readily tradable (eg Small Cap Equities and Fixed Income). As a result we recommend to always place trade orders at a ‘limit’ price, avoid trading at the start and end of day and if possible avoid trading during times of market distress.

ETF issuers are required to disclose the indicative net asset values (iNAV) during trading of their ETFs. This is the actual underlying Net Asset Value of the ETFs at that point in time. This allows investors to be able to see in real time the difference that they can buy or sell an ETF at compared to the actual underlying assets of the ETF. ASIC found ETF issuers did not have a consistent approach to publishing iNAVs and recommended issuers making them more available when they are reliable. Generally you can find a fund’s iNAV by putting a ‘Y’ in front of the fund’s ticker in your Broker search, however not all issuers provide this, with some posting the iNAV on their website. Many ETF issuers do not quote an iNAV at all for international equity or fixed income ETFs, due to the difficulty in quoting an accurate iNAV during Australian trading hours.

ASIC noted that there were a small number of ‘market makers’ (there are only two main market makers), with few having formal agreements in place with ETF issuers. Market Makers play the role of middle man between the ETF issuer and the investor, and create and redeem ETF units when there are no buyers or sellers on the secondary market. ASIC sees some risk in this process without formal agreements in place. They also are cautious of the conflicts of interest present for those funds who do their own market making (generally Active ETFs), as there is opportunity for these providers to add additional profit through their market making activities at the detriment of investors.

ASIC had some concerns about ‘unsuccessful funds’, meaning funds that simply do not have enough assets under management to be commercially viable. In more mature ETF markets, these are quickly killed by ETF issuers, however given the immaturity of our market may be left to run for longer. These funds tend to have higher fees, low liquidity and higher bid-offer spreads. In recent times we’ve seen a few ETFs wound up that received low inflows, so we think this issue will sort itself out as the market matures.

What does this report mean?

Compared to some of ASICs other recent reports and the horror headlines coming out of the Royal Commission into Banking and Financial Services, the ASIC report into ETFs was incredibly positive. This is great news for ETF investors as they can have confidence the Australian ETF market is performing well. It is also great news for the ETF industry who have effectively been given a green light to continue innovating and growing the ETF market. As a result we can’t see any reason for the growth of ETFs to slow down any time soon.

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