by Stephen Small

Only a short time ago, if you were looking to invest in a diversified managed fund, you would call your financial adviser, invest via a platform, or go through the arduous task of completing application forms and posting cheques in the mail.  Like every other facet of our lives, innovation and technology are making laborious tasks like this as simple as one click of a button. 

Let me introduce the Exchange Traded Fund.

Designed to simplify investing, Exchange Traded Funds, have revolutionised the traditional managed fund structure, otherwise known as a managed investment scheme, by listing the fund on an exchange. In effect it makes accessing managed funds as easy as buying a single share on the stock exchange.  

If we delve a little deeper, ETFs most commonly track an underlying index.  This means that instead of the fund manager actively selecting their preferred stocks within the index (and charging a healthy fee), ETFs simply invest in a portfolio of stocks that perfectly mirror the selected underlying index.  This introduces a second benefit, equity based ETFs offer instant diversification across a portfolio of securities within an index. 

In addition to instant diversification, ETFs provide other benefits such as lower cost, increased transparency and liquidity.  

ETFs have been available in Australia for over 10 years.  One of the original and most popular ETFs is the State Street SPRD S&P/ASX 200 Fund, which tracks the S&P/ASX 200 (ASX code: STW).  STW is popular with institutions and SMSFs alike as it allows them to gain broad access to the Australian share market in a simple and cost effective way.

In fact, in Australia the single biggest user group of ETFs is the SMSF market, which makes up about half of the $10 billion currently invested in ETFs.  ETFs, by their inherent nature, are designed for individuals that are looking to take control of their investment decisions and implement their own trade ideas.  With close to 100 ETFs available across every major asset class of equity, fixed income, international equity, commodities and currencies, SMSF trustees can structure and monitor an entire balanced portfolio from their home.  And all of this can be accessed with relative ease through a few simple clicks using a home computer and via an online broker.

Globally, the ETF success story is even more impressive. ETFs have been available for over 20 years and have been so successful that over $2 trillion dollars is now invested in them. With this figure consistently growing at +20% per year, it is no surprise that fund managers around the globe are starting to develop new innovative versions of these products in response to client demand for greater diversity of investment alternatives. To illustrate, all five of the largest fund managers in the world are issuing ETF products.  

So how do you make a simple idea, even smarter?  

Let's talk smart beta.

The term 'smart beta' refers to the underlying indices that an ETF tracks.  By altering the selection criteria for how securities are included in the index, different investment outcomes can be achieved for the end investor.  

Fund managers use this 'smart beta' concept to introduce investment research into the ETF structure with the aim of enhancing the returns to clients.  For example, securities may be selected with a more outcome orientated objective such as low volatility, high dividend, value, or momentum. 

Recently, the most successful 'smart beta' ETFs have been the 'high dividend' funds. Instead of tracking securities within an index eg S&P/ASX 200, it tracks an index which only holds those securities that pay above average dividend yields. 

There are now five ETFs of this nature listed on the ASX with circa $1billion of invested assets. The most recent fund to market is the UBS IQ 'Dividend' ETF (ASX code: DIV) that holds a portfolio of 40 Australian companies that  have both strong dividends as well as sound balance sheets along with a demonstrated capacity to continue paying and growing these dividends into the future.

Underlying company research and high dividend yield now compliment the other beneficial attributes of an ETF including ease of access, diversification, low cost and transparency.

This 'sustainable dividend' product has also been extremely popular with SMSF issuers, particularly, those, in or approaching retirement that rely on the steady flow of dividends as a source of income.   In a low interest rate environment, and with some existing dividend ETFs yielding in excess of 7% p.a (including franking), these funds are becoming a main stream investment tool for retirees. 

 

With the Australian ETF market growing exponentially and showing no signs of abating, it is no surprise that fund managers and investors are both lining up to join the ETF revolution.