What ASIC’s review of ETFs means

ETFs are hot property for retail investors and SMSFs, and for good reason – they’re cheap, provide easy access to diversification and can be traded like any other stock. But ASIC’s recent review of the sector has identified some key concerns.

ASIC said the rapid growth of the ETF market prompted the regulator to take a closer look at how it functions. It’s not difficult to see why – according to 2018 Stockspot research, there’s now about $36.2 billion invested in ETFs, which is 33% more than last year.

Using ETFs, you can now invest your client in European stocks, bonds, emerging markets, low volatility companies and even the price of wheat – the possibilities are virtually endless. But before jumping aboard the ETF train, it’s important to consider the potential risks:

The key factor affecting returns

ASIC’s primary concern was the bid/offer spread, or the difference between the highest price a buyer is willing to pay and the lowest price at which the broker is willing to sell. While ASIC found that generally the spread was fairly narrow, occasionally this would widen to a degree that it could “undermine the relatively low-cost proposition of some exchange-traded products (ETPs).”

The regulator described these spreads as effectively a “hidden cost that reduces and investor’s return,” so recommends a proactive review of how ETF issuers manage the issue.

What does this mean for you? ASIC said advisers need to ensure they inform clients about how these spreads may impact their investment strategy, and to “exercise caution during volatile markets and when trading at the open/close.”

A clearer view on value

Another issue ASIC highlighted was indicative net asset values (iNAVs) – these essentially represent the value of the units held in an ETF relative to the value of the underlying assets in which your clients are invested. By providing an iNAV, you can make a clearer comparison to the price at which the ETF is trading.

Currently there is not a consistent industry-wide approach to publishing iNAVs for advisers and investors, and ASIC said addressing this will involve publishing them when they are materially reliable – and if they aren’t, “consideration should be given to removing the iNAV and potentially suspending trading.”

For your clients, ASIC recommends an education piece about accessing iNAVs, explaining what they are and noting that they may not always be 100% reliable.

Liquidity and market concentration

The ETF market relies on market makers, which provide liquidity to these products by managing trades on the secondary market – i.e., between investors. While ASIC noted there are a growing number of market makers supporting ETF trading, currently “most liquidity is still provided by only two entities.”

Managing this will involve issuers of ETFs and market operators considering how this liquidity concentration could potentially affect their risk management, and will require regular supervision.

Overall, though, it’s worth noting ASIC said the ETF market is “generally functioning well and delivering on promises to investors.” While the benefits to investors are reflected in the rapid growth of the ETF market, it’s always important to consider how these risks may affect investment strategies.

 

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