ETF Myths Debunked
ETFs as an investment vehicle have gained immense popularity in the last ten years, as investors have begun to prioritise instant and liquid exposure to global markets. Australians currently invest almost $70 billion across 200 products listed on the ASX, with recent data showing cash inflows into ETFs at a record high. The increase in ETF uptake has prompted some critics to question whether they could become a catalyst for the next market crash. Below are some myths surrounding ETFs.
Myth 1: ETFs exacerbate market volatility
While there’s a theory that the liquidity of ETFs can lead investors to be less disciplined during bouts of market volatility, Vanguard research has found that investors in their ETFs tend to hold tight during periods of instability, with the vast majority of their investors trading just once a year. Hence, although the option to trade is readily available, the more frequent the trades, the more costs that will be incurred and the less profits that will be returned.
Statistics also show that an overwhelming majority of trades on the ASX still continue to be equity trades, with ETFs only comprising a mere 3% of the ASX’s $8.7 billion daily traded value. Ultimately, history has also shown that there is little correlation between ETF performance and market volatility.
Myth 2: ETFs negatively impact market liquidity
There are two levels of liquidity to think about when it comes to ETFs.
The first is shown in the number of shares available for purchase or sale at a particular price during the trading day. Unlike open-ended mutual funds with offer liquidity only at the end of the day, ETFs are traded throughout the day on exchanges. By facilitating demand from buyers and sellers through a transparent, exchange-traded instrument, ETFs may actually provide incremental exchange liquidity beyond that of the underlying asset (which are shares).
The other criticism regarding ETF liquidity relates to the concern that there are too few market makers (akin to brokers) providing liquidity in the local ETF market and that investors will be adversely impacted should one or more withdraw. Most ETFs are covered by multiple market makers competing against each other for investors orders. Realistically, if a market maker were to withdraw, others would seize the opportunity to step into trade with an investor.
ETFs actually proved during the COVID-19 volatility to be a reliable source of liquidity for investors. While individual security liquidity diminished, ETFs took on the role of “shock absorbers” for the market, as trading $10,000 of an ASX 200 ETF is spready across 200 individual securities and causes less volatility as opposed to $10,000 of an individual company’s shares.
Myth 3: All ETFs are created equal
Not all ETFs are created equal, and so not all will offer the same low cost, liquidity and diversification benefits that ETFs in general are known for.
We have in recent times seen an increase in niche ETFs. Unlike a broad-based ETF that tracks the returns of an underlying market index, niche ETFs are constructed around a specific subject e.g. gold, oil, healthcare. As they are more specialised, these niche ETFs are more risky and largely lose out on the diversification benefits that a broad-based ETF offers.
The rise in niche ETFs and the nature of such products may also encourage investors to engage in more frequent day trading. Not only will this accumulate additional costs, but will also increase the unpredictability of such products and ultimately lead to lower returns for the investor.
Important information and disclaimer
This document has been published by Mark Welch & Lachlan Carmody, EPG Wealth, Pty. Ltd. Authorised Representative(s) of Apogee Financial Planning Limited (ABN 28 056 426 932) (“Licensee”), an Australian Financial Services Licensee, registered office at 105 –153 Miller St North Sydney NSW 2060 and a member of the National Australia Bank Limited group of companies (“NAB Group”) .
Any advice in this publication is of a general nature only and has not been tailored to your personal circumstances. Accordingly, reliance should not be placed on the information contained in this document as the basis for making any financial investment, insurance or other decision. Please seek personal advice prior to acting on this information.