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Passive investing has seen huge growth in the US, with 35%-40% of daily trade volume on the New York Stock Exchange in ETFs, and even more in Canada, Scott Burns, Morningstar director of ETF Research tells the Morningstar Investment Conference.
Why is this happening? Firstly, Burns says, it’s an expense story. The average total expense ratio for all equity ETFs is 0.40%. If you are going to invest passively, invest cheaply, he adds. In comparison, OEICs charge on average 1.8%. Investors need to understand that a manager has to deliver more than the difference between these two ratios to make it worthwhile for the investor and this is the simple maths of the passive vs active debate, he says. Liquidity is another important advantage, Burns, says, noting that the SPDR S&P 500 ETF (SPY) is the most liquid security on the planet, even more liquid than the securities underlying it. Access to new asset classes – while a double edge sword – is another key advantage of ETFs, Burns points out. Regardless of the vehicle, a gold bubble burst will be painful, that is not disputed, but ETF investing yields more benefits than simply holding physical gold in your bank account and significantly limits the transaction costs and friction that the latter would entail.
So, go active or go passive? The most sophisticated investors do both, Burns says. It allows you to, for example, be invested in an area where you know your active manager of choice might be a little weak. It’s not all sunshine, of course. ETFs never claimed to make your life easier, but they will make it cheaper, Burns quips. Talking about complexities, Burns notes that with multiple ETFs tracking the same index, there’s an important need for understanding and knowledge when investing.
What does Burns say to Jack Bogle’s famous “ETFs are terrible?” It is ironic that this statement comes from the man who came up with index investing, he says.
Strategies that are well known in the OEIC space, such are relying on non-correlated beta, can be seen in ETFs as well. ETPs can also be seen as a liquidity boost on a portfolio, using ETFs to counterbalance more risky allocations. The explosion in fixed income products allows the investor to slice and dice, to buy emerging markets bonds, short or long duration bonds. We are in a position currently whereby, when looking for income, we need to be a lot smarter about how we approach the sector and the ETF space provides a huge range of options are low cost.
Burns looks at a creating a diversified portfolio with ETFs for core and alternative asset classes and demonstrates how these products can stabilise a portfolio’s volatility as well as yield returns beyond a single equity index. He welcomes the opportunity to plug the recent launch of Morningstar’s ETF Research, covering 150 exchange-traded products and counting.
In response to a question from the audience on a recent regulatory report into synthetic ETFs, Burns notes that there is some incremental risk that goes with these vehicles and highlights that Morningstar is calling for more transparency on these vehicles within the industry.
