Subscribe to get our latest investment news and insights straight to your inbox.

ETF mysteries revealed

What is an ETF and Why We Prefer Active ETFs

ETF stands for Exchange Traded Fund and is shorthand for a parcel of securities (usually shares or bonds) that are traded in the same way as a single stock.

In other words, it’s a simple way to own a portfolio of securities rather than a single one.

For decades, retail investors seeking to construct a portfolio of shares or any other asset class were forced to purchase those shares individually or look to unlisted managed funds. Now ETFs are able to fill that void and allow investors to quickly and easily provide exposure to diverse portfolios of stocks, bonds and other asset classes via a single investment on a public exchange such as the ASX or Chi-X.

In recent times, the role of Exchange Traded Funds has continued to grow as ETFs offer lower trading costs and greater flexibility compared to traditional managed funds.

An important recent development in Australia is the development of Active ETFs. Active ETFs are a type of ETF where the portfolio is actively managed by a team of professional fund managers (as opposed to replicating an index, more on that below). At eInvest we focus only on Active ETFs, but think it is important to understand how ETFs work more broadly.

In this article, we may use the generic term “ETF” to refer to both passive ETFs and Active ETFs.

How do ETFs work?

ETFs are created by the ETF provider but it is you, the unitholder or investor, who ultimately owns the underlying assets. The provider designs a fund and then sells units in that fund to investors that are tradeable the same way shares of a company are traded on the exchange.

ETFs are structured similarly to unlisted managed funds.. They are also similar in that both issue product disclosure statements that layout their investment objectives, investment methodology, fees and expenses and other essential information investors need to know.

What are Active Exchange Traded Funds (ETFs)?

Active ETFs differentiate themselves from the original index-replicating ETFs by being actively managed, usually because they are not following a specific index. They are sometimes also known as Exchange traded Managed Funds (ETMFs).

There are now more than ten active ETFs based in Australia distributed by well-known organisations which include eInvest.

The managers of active ETFs choose which stocks to buy but their fees are still low in comparison with the brokerage costs of buying individual shares.

Why we prefer active ETFs

The goal of an active ETF is to outperform an index or certain benchmark. Active ETFs rely on the skill and ability of experienced portfolio managers to ideally outperform those benchmarks.

As such, active ETFs are also able to focus on a wide variety of investment strategies and can offer a greater level of diversification for investors looking to reduce their overall market risk.

For many years in Australia, ETFs were closely linked to passive investing. In Australia and much of the world, passive ETFs made up the majority of ETFs. However, since 2015, the role of active ETFs in Australia has started to grow rapidly after legislative changes around portfolio disclosure changed, opening up a whole new world of opportunity for investors.

Indicative Net Asset Value (iNAV)

iNAV stands for indicative net asset value and it is an important part of understanding how  Active ETFs operate.

iNAV is the estimated total net assets held under management in a portfolio. The iNAV will move up and down as the underlying securities in the portfolio move. In a similar fashion, your stock portfolio changes on a day-to-day basis.

Understanding iNAV is important as it highlights another of the key benefits of investing in ETFs over managed funds. A managed fund will calculate its Net Asset Value once per day – usually at the close of the session. Some funds might even calculate it less than that.

Managed funds have unit prices, which are the daily net asset value per unit of the fund. This often means that investors are only able to buy and sell units at the end of the day at best.

iNAV, on the other hand, is important for ETFs. Because ETFs trade on a public stock exchange like the ASX, they need to be able to calculate their NAV throughout the session. That’s why they come up with an indicative NAV (iNAV) – which is estimated and made public, in eInvest’s case, every second.

iNAV gives investors an accurate idea of what a fair price for the ETF might be and it acts as a good estimate as to how much you should be paying when buying or selling.

What is ETF investing?

It’s possible to buy and sell ETFs and gain exposure to the market in much the same way you would through using products such as other . However, ETFs are often a quicker, easier, more flexible and cheaper option for many investors.

ETFs can contain all types of assets such as stocks (share ETFs), commodities (commodities ETF), or bonds (fixed income ETFs), both from Australia or around the globe. The majority of the different types of ETFs are passive ETFs and simply contain a basket of securities that track an underlying index. At eInvest we like to seek beyond the index, which is why we focus on Active ETFs.

ETF investing may allow you to create a diversified portfolio that suits your goals and risk profile while still having the flexibility to quickly and easily be bought and sold.

What are the Advantages?

If you are starting out in share ownership, it is a particularly helpful shortcut to having a more diverse holding. Aside from making sure your investment goes up in value, one of the key elements you must look for in investing is diversity (also known as diversification).

ETFs have taken off in a huge way in the US, making up a large percentage of share trades overall, while they have taken longer to get going in Australia.

Portfolio construction

Via ETFs, investors are able to construct a diverse portfolio of assets, quickly and easily while having flexibility and control compared to traditional managed funds.

ETFs may focus on both stocks and bonds or other different asset classes. Investors can easily construct a diversified portfolio using one or many ETFs, including a mixture of active and passive. There are so many different ETFs that the options are virtually limitless as to how you could construct a portfolio.

ETFs are also a powerful tool for investors as some offer leverage (leverage ETFs) or the ability to trade the inverse of an asset or index (inverse ETF).

Role of brokers and online brokers

It’s possible to buy and sell ETFs through online brokers and traditional broker-dealers. The changing landscape of financial markets and financial advice over the past decade has seen a significant amount of money being directed into ETFs via both types of brokers.

Spreads

Because ETFs are traded on the open market via stock exchanges, there are some considerations you need to take into account when placing orders to buy and sell.

The difference between the current bid and ask is known as the spread. For popular and very liquid ETFs, spreads are generally very tight, meaning there are plenty of buyers and sellers,  making it easy and relatively inexpensive for investors to enter and exit their positions.

However, in some less popular or more niche ETF investing products, there might be less active participants and therefore wider spreads. This is something to take into consideration for investors if they need to liquidate their position in that ETF quickly when calculating their risk.

Income or Growth

The beauty of ETFs is that increasingly there are more and more that focus on different subsets of the overall market. For example, you can invest in ETFs that are focused on higher growth stocks, which are stocks that are considered to have a stronger potential growth over time.

Conversely, there is also the ability to invest in ETFs that focus predominantly on yield or income. Depending on your financial goals you can choose an ETF to match what you’re trying to achieve.

Diversification

Arguably the biggest benefit of investing using ETFs is the ability for quick and easy diversification. With ETFs that focus on different market sectors, different industries as well as different asset classes and even countries, you can quickly and cheaply construct a highly diverse portfolio, that will help you in reducing your overall portfolio risk when invested in ETFs.

Asset Classes

These days, investors are able to access virtually every asset class, commodity and currency around the globe using ETFs.

It’s possible to invest in stocks, bonds, REITs, commodities, currencies. There is also the ability to invest in more exotic assets such as market volatility or inverse ETFs, allowing for increased diversification.

Sectors and Themes

Sector ETFs track within specific industry sectors instead of the wider market. These sectors might include banks, resources, technology or property. Investors are able to easily gain exposure to these various sectors by purchasing Australian Sector ETFs.

Role of market makers with ETFs

Market makers play an important role in the way ETFs function. To understand why market makers are important, it’s first important to know how ETFs differ from a traded company. ETFs are what is known as open-ended funds. This means that there isn’t a set number of shares like there would be for say a company.

The number of shares for a given ETF differs with demand from investors. To meet the changes in demand, market makers are appointed to make sure there are enough shares available on offer to meet investor demand at any given time.

So effectively, market makers add liquidity and make it easier to buy and sell an ETF or even trading ETFs. Hence they play a very important role in how ETFs function every single day the market is open during the trading day.

Close-ended vs Open-ended Funds

Closed-ended funds, such as Listed Investment Company (LIC), have a fixed number of shares or units on offer. This is similar to the way in which a company that is listed on the stock exchange works.

The company can only issue new shares through very specific corporate actions such as rights issues, placements, dividend reinvestment of share purchase plans etc. Effectively the supply of shares is limited.

Open-Ended funds on the other hand, such as Active Exchange Traded Funds (Active ETFs) or Index Exchange Traded Funds (Passive ETFs), have the ability to create new units as demand and supply change.

If new investors buy into the ETF, more units can be created. Similarly if investors exit, units are able to be cancelled. The ETF grows and expands based on how active investors are as well as how the fund is performing.

With some open-ended funds, the additional liquidity is provided by market makers who are authorised market participants. Alternatively, that liquidity can be provided by the fund itself.

Fees – how are they calculated and charged?

One of the key benefits of ETFs is the fact they offer lower costs than traditional managed funds. However, there are still going to be some slight differences in costs between different types of ETFs.

Passive ETFs are designed to track an index and as such, have lower costs. Their costs are simply those that are associated with running and managing the fund. The key difference with this type of ETF is they don’t seek to outperform the index they track and, as such, require less skilled and experienced money managers.

Active ETFs employ managers to research, analyse, or trade securities and therefore have slightly higher costs than their passive cousins. However, it’s important to understand that the goal of an active ETF is to outperform a given benchmark. If the active ETF successfully achieves that goal, the difference in costs is well and truly justified.

The way to assess and compare ETF costs is by looking at the expense ratio, which is expressed as a percentage, is a management fee that is deducted from the fund’s assets.

For example, an ETF with an expense ratio of 0.50 per cent would deduct half of one per cent from the fund’s assets annually.

Normal ranges for ETF fees

ETF fees vary by the type (active vs passive) and also the country in which they are traded. Generally speaking, in Australia (Australian equity markets), there are around 200 ETFs currently available with the management fees ranging from 0.07% to over 1.3%.

At the lower end of the scale, passive ETFs can have management fees as low as 0.15-0.2 per cent.

Active ETFs have management fees that can vary between 0.45-0.85 per cent generally, but costs will differ based on the investment strategy and asset class.

It’s also important to note that passive ETF costs can be significantly less than managed funds,  attracting costs of anywhere from 0.5-3.0 per cent per annum. The lower fee charged by passive ETFs is an obvious advantage. It has even influenced some Active ETF providers (including eInvest) to issue their Active ETFs at a lower management fee than similar unquoted unit trust structures.

How to buy and sell ETFs

Buying and selling ETFs is a similar process to that of investing in shares of an individual company. Investors are able to invest directly in an ETF through a stockbroker, either online or through a traditional broker-dealer.

To invest in an ETF with your online broker, you’ll need to know the ASX or Chi-X code for the ETF.

The broker handles the settlement of buying or settling the ETF. Settlement of trades generally takes place two business days after you buy or sell an ETF, in the same way as a share in a company. You’ll also have to pay brokerage fees via your brokerage account when you buy or sell your ETF.

What are the risks in buying ETFs?

They tend to be less volatile than individual stocks, which means you won’t capture all the price upside that a single popular share would enjoy, but in a downturn, you are potentially running a lower risk of losing your investment.

While it is often correct that around 60 per cent of active fund managers underperform their benchmark indices over the short term, the best fund managers consistently outperform the market, more so over the long term and particularly when things turn bad.

Cynics point out that if you own an ETF you are guaranteed to underperform the market, because you have an annual management fee (of maybe one third of one per cent) to pay after your ETF has faithfully followed the market.

As a fund manager once said, an ETF can be guaranteed to reflect all of any fall in the market during a downturn.

Risk of Doing Nothing

If you are looking to make a return you will need to take a risk. However, all risks are not created equal.

If you buy a diversified portfolio of blue-chip shares through an ETF, the reality is that the portfolio will fluctuate with the market, but over a long period of time, it will continue to grow in value. There might be risk associated with holding that portfolio, but there can be more risk if you do nothing.

By correctly structuring your portfolio with proper diversification across asset classes, investors are able to capitalise on the long-term growth of productive assets such as shares, while minimising both volatility and risk.

Currency Risk

If you invest in a foreign ETF in a currency other than AUD, then there is a currency risk associated with currency fluctuations.

While the ASX is a great place to invest, there is a strong focus on both resources and financials and investors might want to look to other countries to help diversify their portfolios beyond what is offered locally. A simple example might be an Australian investor wanting to purchase an ETF tracking the S&P 500 index (such as the SPY), but not want the risk of holding USD.

A simple way to remove currency risk by investing in ETFs that are traded on the ASX and hedged for currency movements. There are now a number of currency-hedged ETFs available on the ASX, where the exposure to foreign currencies has been removed as part of the ETF design.

Liquidity Risk

Just like with individual shares, some ETFs are more highly traded and liquid than others.

When buying and selling an ETF (or a stock for that matter) there is the risk of there not being enough liquidity to easily trade. Poor liquidity is reflected in a wide bid/ask spread and low average trading volume.

In times of crisis, the risk of liquidity drying up is even higher and it’s even more important to ensure you are investing in an ETF that has enough liquidity to allow you to exit your position without paying a wide spread or without moving the price significantly against you.

The best time to assess the liquidity of an ETF is before you decide to place an order to buy. That way, you’re protected from liquidity risk before choosing to invest.

How volatility and risk are different

It’s important to understand that there is a difference between risk and volatility when it comes to investing – particularly in ETFs. Just because something moves up and down in price, doesn’t necessarily make it risky.

Risk is really associated with the probability that an investment will result in permanent loss of value. Whereas volatility is how significantly an investment tends to change in price over a period of time.

When we look at ETFs that track an index such as the ASX300, we might see that they change in price quite a bit. We are seeing that quite a bit in 2020. But that doesn’t make that investment risky in terms of that portfolio of shares losing permanent value.

We can use ETFs to help construct diversified portfolios to help reduce both risk and volatility. This is a core asset allocation strategy that’s possible by investing in different uncorrelated asset classes that will ideally perform across different market conditions.

That process gets taken one step further when you start to add actively managed ETFs into a portfolio. Active ETFs not only allow investors exposure to certain asset classes, but they also include the skill and experience of investment managers who are able to implement strategies that further seek to reduce risk and volatility.

Overview of the ETF market

ETFs are a low-cost way to quickly either track an index or commodity or invest in a portfolio of stocks or bonds (bond ETF) that seeks to outperform a given index. They and are a way that investors can create a highly diversified portfolio that offers lower risk.

In Australia, the majority of ETFs are passive in that they try and track an index, such as the ASX200 (stock ETFs) or a commodity such as Gold. However, there are also active ETFs that seek to outperform a given index and rely on the skills and experience of portfolio managers.

On the back of strong market conditions, the ETF market both in Australia and around the world continues to grow every year. In Australia, the ETF market finished 2019 with $61.5 billion under management, with Active ETFs representing $5 billion under management.

How do you get started?

Buying and selling ETFs is no more complex a process than buying shares. You can choose a traditional “full service” stockbroker although it’s just as easy to open an account with one of the discount stockbrokers such as nabTrade, Commsec or BellDirect.

To get information on our Active ETFs you can review the product disclosure documents by clicking on any of the following codes EIGA, IMPQ, ECAS, ECOR or EMAX.

For more detail, please see the relevant Product Disclosure Statement (PDS) for the active ETF you are interested in. This article is the opinion of the author and is not financial advice. Speak to your financial advisor or broker for more information. I’m sure they’ll be happy to help you.

“Disclaimer: Please note that these are the views of Camilla Love, MD of eInvest, and is not financial advice.To find out how to invest in our active ETFs, visit here. The product disclosure statement and more can be found at www.einvest.com.au To find out how to invest in our active ETFs, visit here. The product disclosure statement and more can be found at www.einvest.com.au

Transcript

Jodi Pettersen:

Hello everyone. My name is Jodi Pettersen. Thank you all for joining us today. I work for einvest and at einvest, we are all about active ETFs. We think that everyone should be able to access awesome quality active management on the exchange and you should be able to buy and sell portfolios in an easy and transparent manner. But first thing is, before we do that, we have to work out what are ETFs and how do they work? Today we’ll be focusing on those exact questions and I’m going to be having Camilla love, who’s the managing director of invest, make the presentation today. Before we jump in though, let me remind everyone that, of course, today we’re speaking in a general nature only and this is not financial advice. Please always seek your own advice, read the PDFs and remember to also just speak to a financial advisor if you’ve got any questions. There is a Q&A format here so you can submit questions and I encourage you to do so. We will try and keep this really quick but enough talking from me. Let me pass over to Camilla who is going to uncover the secrets of what active ETFs are.

 

Camilla Love:

Thank you, Jodi, and welcome everybody. A little about einvest first to give you a little bit of context. As Jodi mentioned, einvest is an active ETF specialist and we only provide active ETFs in areas where active management makes sense and, in our circumstances, is income generation, Australian small caps and fixed income currently. We believe that Aussie investors just like you are seeking greater control and decision making across their investments and that you’re trying to do that through liquid and transparent, easy to manage, and lower cost options, but you still demand access to high quality portfolios and that’s what einvest is aiming to provide you through our active ETFs. We currently have five tradable active ETFs on the market at the moment and we’ll continue to grow our suite over time. While einvest is only new, we form part of the perennial group of businesses. Perennial is a $6.5 million fund manager who’s been around since the early 2000s.

 

Camilla Love:

Again, thank you for joining us. What are ETFs exactly? What are the basics to know? Let’s start from scratch and we’ll go from there. If there are any questions, as Jodi mentioned, terms or areas you’d like me to go into more detail, please send through your questions so I can tailor our chat to your needs. No question is too big or too small so I encourage you to pop them into the chat. ETFs stands for Exchange Traded Funds and that is exactly what an ETF is. A fund that can be traded on the exchange under one ticker code. They trade just like a share. You can buy and sell them just like a share. There are two exchanges that offer ETFs in Australia, the ASX and Chi-X and most good brokers out there route through both exchanges to ensure that good competition and pricing.

 

Camilla Love:

For the day to day investor like you and me, you don’t know or actually really mind which one it’s traded on just as long as you’re getting the best prices for your trades. The ETF itself comprises of a portfolio of securities. It could be 10 securities, it could be 2000 securities. It all depends on the investment philosophy or universe of the fund. Before the invention of ETFs, to achieve diversified portfolio of many shares, investors had to buy shares individually, and it’s still very much common practice, but as people’s lives are becoming more complex, ETFs are a great way to start your investing journey, minimize the cost, provides you greater diversification for your dollar and gain access to global markets specific sectors that were really only previously accessible to institutional investors. the ETF market in Australia is approximately just under $60 billion, at last count, and there are over 200 ETFs to choose from. Recently, investment trends who do a lot of research in the investment segment of the market forecasted that there would be over 401,000 individuals, just like you and me, investing in ETFs in 2020 of which 135,000 will be new to investing in ETFs. If you’re one of these newcomers, welcome. If you’re an old hand, thank you for paving the way for the growth of ETFs. It’s really clear that the investment approach has lots to offer investors, both expert and newcomers.

 

Camilla Love:

Onto the next slide, you can see a wide range of asset classes are available in ETFs and, actually, the global ETF industry ended the third quarter of 2019 at a record high with US dollar $5.8 trillion in assets under management reflecting a growth of 20% year to date. Here in Australia, the ETF market, as I mentioned, is just under $60 billion and it’s grown a lot and you can see that in the left hand chart between the first ETF was launched in 2001 and then obviously till now. There was a large number of products that were listed last year alone. There was about 24 new products coming to the exchanges for tradeability and, particularly, there’s the new phase of what we call active ETF products. Active ETFs now represent 11% of the ETF market here and I believe that the Aussie market is really in its established to growing phases, given that offshore, the ETF markets are very, very large and it will continue to grow here in Australia and support new ETFs coming to market over the coming years.

 

Camilla Love:

As you can see with the donut chart on the right hand side, there’s a great assortment of choice in the types of ETFs available to investors. You can see that it is strongly equity related. You can see the two really large components of that with global and Australian equities comprising the majority. There’s been great new developments in fixed income ETFs, which has seen wonderful growth over the last year. Giving investors access to this market, which generally would have only been available to professional investors. Active fixed income ETFs are relatively new to the market and is something that people should think about, given the time of the cycle. All these ETFs are conveniently available on the exchanges and generally at a lower cost.

 

Camilla Love:

Turning to the next slide, what are the types of ETFs out there? You can see from the last slide, there were lots, and I’ve put a few terms down here that might assist you in to assess what you’re actually interested in. Firstly, index tracking or passive ETFs, which comprise the majority of ETFs because they were the original format. They track common indices, whether that be the ASX 200 or MSEI and I’ll discuss them a little bit further on the next slide. There are actively managed ETFs at einvest, as I mentioned, we only provide actively managed ETFs. And that means that our ETFs target a specific outcome, whether that be performance or income related, and tap into the investment expertise of professionals who do it day in and day out. The third option is thematic ETFs and they, as it sounds, focus on a theme, whether that be artificial intelligence, healthcare, energy, or the like, and these are useful if you want to invest in a segment or a theme that you’re really passionate about or see an investment opportunity. Often the fees are generally a little bit higher in these funds and so that’s something to assess.

 

Camilla Love:

The fourth sector is sector asset class and commodity ETFs. Examples of those are healthcare and tech, as a class as such as real estate infrastructure and commodities, such as gold. They are widely available emerging markets and regional sectors and, particularly, we’ve seen today, given the volatility of the market, that gold ETFs have been a relatively popular, given its defensive properties, and their ETF’s have great way to access these segments of the market.

 

Camilla Love:

Moving onto the next slide, I’ll go into a little bit more depth. Passively managed ETFs and actively managed ETFs. The first ETF in Australia was established in 2001 and the first one, internationally, was actually in 1993 and are still reasonably popular, both tracking indices. As I mentioned before, passive ETFs are by far the largest segment in the market, globally and also here in Australia. There are a large number of brands that offer passively managed ETFs to investors and are really not hard to find. And I’m sure there’s content online about a number of those. Passive ETFs, as I mentioned, generally attract it in the index and that might be an ASX 300 index, if you’re interested in Australian shares, but that can be widely available but those indices also can be developed by ETF providers in conjunction with the index provider.

 

Camilla Love:

They are generally based on a set of rules and processes that are predetermined. They are always, in the most circumstances, lower in cost but can vary widely based on asset class or strategy so it’s worth doing your home homework. Just a quick note on indices, Not all indices are made the same and I would like to highlight probably fixed income indices, as an example. They’re very different to equity indices. Equity indices, in the main, are based on market capitalization. Fixed income indices are actually comprised of companies who actually provide the market the most debt and so, therefore, they are very indebted, which actually might not be worthy of investors money.

 

Camilla Love:

Also, as I mentioned before, indices can be made up and so there’s a number of great examples out there, particularly with sustainability focused indices if you’re that way inclined, that might have actually a percentage of revenue tolerance to coal, which actually might not line up with your sustainability values and even equity indices can vary quite differently whether it’s based on market cap, as I mentioned before, like the ASX 200 or 300, are all based on other accounting metrics like company sales, cash flows and book values. It’s always best to understand the index that you’re investing in if you plan to invest passively and as I recommend with everything, do your research into this segment.

 

Camilla Love:

As for actively managed ETFs, they are a new innovation in the ETF market globally. Australia’s first active ETF began in 2015 and other countries have followed with America and Hong Kong, more recent additions to offering active ETFs. As I mentioned a couple of slides ago, active ETFs generally target a specific outcome, whether it be performance or income or other related, and tap into the investment expertise of teams of professionals. And, as you know, einvest only provide actively managed ETFs. There are a number of things to think about with active ETFs. Team members can change, poor performance can occur, fees can also be higher and at einvest, we place importance on a net of fees outcome for our clients.

 

Camilla Love:

Moving on to the next slide, 10, we’re talking a little bit here about portfolio construction and we’ve designed this framework as a tool that might assist you when looking at putting your portfolio together. And these factors … Here is a guide for you to consider when making portfolio construction decisions and allocating between active and passive strategies amongst your ETF portfolio. Whilst it’s not always clear cut, there are some strategies that clearly better suited to passive and vice versa. For example, currency ETFs are very low cost and a easy way to access wholesale rates of various currency exposures or a broad base, low cost equity ETF, you might want to sit alongside an actively managed ETF in sort of what we call in the industry a core and satellite approach. Equally, we think it makes a lot of sense to go active when allocating to segments that you can see up in the top right, left hand corner, small caps. Given the nature of this sector, which is large, generally under researched with poor analyst coverage, or even in the case of fixed income, the which passive ETFs may have very long duration in an economic environment where interest rates will be lower for longer. We think that active management actually does make sense in these segments.

 

Camilla Love:

How do ETFs work? What are the mechanics behind them? I’ll uncover these details in the next few slides, but first it’s important to introduce you to some key terms to understand. Those terms, looking at slide 12, you can see a number of terms on this slide. The NAV, which is, you’ll see, associated with all ETFs. The Net Asset Value, which is the total net assets under management of a portfolio per unit. Then you’ve got … Which is essentially the value of the underlying units. You’ve got an iNAV, which is an indicative Net Asset Value, which is the intraday Net Asset Value based on the portfolio and reflects the actual NAVs. The term above calculated in our circumstances every second.

 

Camilla Love:

Then you’ve got a market maker and they’re really important to an ETF process. They provide the liquidity to ETFs when traded on the stock market. They work with the responsible entity or the owner of the ETF to create and redeem shares to keep ETF’s price fairly. We can go a little bit more detail into liquidity in not too long. The DRP plan, the Dividend Reinvestment Plan. If you prefer your dividends to be reinvested in the ETF instead of accepted as cash, you can sign up to the DRP plan. You’ll find these on most of the issuers websites and I do recommend that you either make a selection into your DRP plan or provide your bank account details and select the cash option. It all depends on your investment circumstances on whether which one you would like to choose. And then the fifth term is the bid ask spread. This is the difference between the price you could buy and sell units in the ETF.

 

Camilla Love:

How do they work in more detail? You see on slide 13, this graph represents the general mechanics of einvest’s active ETFs. Some other providers will differ. However, the concepts are probably broadly similar and passive ETFs are similar but, again, may differ slightly. On the left, if we start there, we start with the portfolio management team who researches and selects securities that aim to meet the objective of the portfolio and I’ll use an example throughout this one. One of our funds is the ticket code IMPQ or the einvest future impacts small-caps fund. Damien Cottier is the portfolio manager there and he and his team, there’s a team of eight in the team there and the small caps team, he selects roughly about 40 Australian and New Zealand small cap stocks for his portfolio and it aims to outperform the ASX small [inaudible 00:19:12] index.

 

Camilla Love:

Every day, moving along to the next box, our custodian send the IMPQ portfolio in a, what we call, portfolio constituent file, a PCF file and it’s NAV to our independent iNAV provider. Our independent iNAV provider is Ice Data Services and it’s really critical, or what I believe is critical, to ensure that there is independence in valuing the iNAV rather than doing it yourself. They independently estimate, every second, the valuation of each individual stock in the portfolio and, as such, the total portfolio itself, the estimate of the current valuation is called the iNAV, as I mentioned before. Ice then distributes the iNAVs out to the world. In general terms, major exchanges, et cetera, which appears in your broker feed and also appears on our website every second to keep you up to date.

 

Camilla Love:

In most circumstances, each ETF has a market maker and as I mentioned before, the market makers role is to provide liquidity to buyers and sellers so that if you choose to buy, for example, 10,000 units in IMPQ and your next door neighbor chooses to buy 5,000 units IMPQ, the market maker will stand in the market and match each trade. And at the end of the day, they report the net units traded per day to the fund and the fund then issues or redeems those units. This means that in normal circumstances, there’s always someone buying and selling on the fund’s behalf. The process always ensures that there is close to no discount or premium to NAV, which is unlike LICs and LITs that there are some people who dislike that. Basically, the market makers are there to buy and sell the units from you when you need it.

 

Camilla Love:

To buy and sell your units, you can log onto your online trading account or call up your broker or financial planner or search for the ETF code that you’re interested in and, in this example, IMPQ, and you type it in to your online broking account and you transact the day and time and price that you want. And I appreciate it this is reasonably dry but it does differ a little bit from shares in LICs and it has many benefits that are useful to investors so well worth delving into the details here.

 

Camilla Love:

How to invest, as I mentioned, read the PDS. It’s super important. You can contact your broker and advisor and log in to your account, you enter the ticket code for the ETF you’re interested in, and then you purchase your units and shares. You can see we have five ETFs there available, varying from Australian shares, small caps and fixed income. What are the risks associated with ETFs? And these are general in nature and these are just a few to consider. You can read more about the risks that are involved in ETFs. If you go to einvest.com.au/what-risks-are-associated-with-etfs.

 

Camilla Love:

But I’ll run through a few common examples. Market risk is noted here. This is the risk that the market in which the portfolio goes up and down. I think most people are acquainted with market risk. Liquidity risk. A lot of people talk about liquidity risk in ETF and the main thing to think about really is that, what are the underlying securities that the ETF is invested in? The liquidity risk associated with, say for example, our EIGA fund, which invests in income generating Australian shares, they are generally a larger cap and they’re generally very liquid but say, for example, others, you might have some liquidity risk or it’s worth assessing the liquidity risk by looking at the underlying securities that the ETF has invested in. There’s the iNAV risk, which we’ve noted. That’s the risk of the independent iNAV is not pricing correctly to the underlying assets. There’s trading risks, there’s investment specific risk. as I mentioned on the previous slide, read the PDS for the fund in which you’re interested in investing in because it will list all the specific risks for the portfolio and it’s really important for you to understand it.

 

Camilla Love:

What are the tips to consider when evaluating ETFs? And these are just of general advice as well and these are the things that I think about myself. Understand your own personal circumstances and personal and investment goals. It’s really important as your first starting point. Seek advice when needed and if appropriate. Understand what the ETFs hold and consider diversification benefits, not only in the number of securities that the ETFs hold, but also the sector allocations the portfolio invest in. For example, a number of fixed income ETFs have a really large component to financials, others don’t, so well worth working out what sectors the portfolio is allocated to. Understand the risks involved including the risks of the index composition if you are investing passively and then, obviously, actively as well. Consider pairing active and passive ETFs together to get a good net of fees outcome.

 

Camilla Love:

As I mentioned before, definitely, you need to read the PDS. You can go for more information at einvest.com.au, COMSEC, Bell Direct, NAV invest, all the major brokers have a lot of information on this. Exchanges, ASX and Chi-x also have a lot of information and other ETF providers. But, really, the hardest thing, as with most things, is to start. Many people ask me what is the minimum I need to invest? And really there’s no minimum. You can buy just one ETF unit if you like and access it for, in our case, just under a dollar, which is in EIGA circumstance. But there’s other things to think about when you do that is the brokerage amount, et cetera, et cetera. Some of the brokers also have minimum dollar spends so well worth having a bit of a looksy there. All in all, we want all Australians to become better invested and ETFs are a great way to do it.

 

Camilla Love:

If you’d like more information, feel free to email me. My email is [email protected] or you can visit our website, www.invest.com.au. Thanks for joining us today for a quick 101 into ETFs and I look forward to answering any questions you might have.

 

Jodi Pettersen:

Thanks, Camilla, for that one. I have had a couple of questions come through that I would love for you to answer. The first one came, is our einvest funds internally or externally market makered?

 

Camilla Love:

We have a dual approach. Two of our funds equity-based, EIGA and IMPQ, and they have an internal market maker and that market maker is MacQuarrie and ECAS, Ecore. And EMAX have an external market maker and that a market maker is [inaudible 00:29:16] bank.

 

Jodi Pettersen:

Fantastic. And what about liquidity? I’ve got a couple of questions come through about liquidity. How does the liquidity work in ETFs?

 

Camilla Love:

It wasn’t mentioned in the session. You need to look at the quiddity of the underlying assets. The exchanges are generally quite strict at what gets put in ETFs and you do have to show a liquidity variability in there. There is, relatively, … You won’t find very illiquid things in an ETF just because the exchanges generally won’t allow you to list that ETF because of that. But as I mentioned, say for example, in EIGA and IMPQ, because they’re Australian shares, they are a little bit more liquid. IMPQ, I would say, is probably a little less liquid only because it’s small caps and there’s a segment of the market. But, in saying that, it’s well liquid. We can liquidate both those portfolios within a day.

 

Camilla Love:

It’s unlike LICs and LITs, where the liquidity is actually based on … Because it’s closed ended. And what I mean by that is, at IPO, there is no ability to issue more shares in the underlying … You’re an investor and you essentially have to have someone in the market buying and selling your share. With ETFs, it differs slightly where the responsible entity that the fund owner will always buy and sell the units or shares of the ETF on the market as you trade it. And, as I mentioned before, it gets netted off at the end of each day and they generally settle at the end of each day. You might see in the screens 10,000 IMPQ units, but actually the liquidity is way more deeper than that.

 

Jodi Pettersen:

Another question I’ve got here, what’s the difference between these funds and some of the popular Vanguard funds?

 

Camilla Love:

Yeah. Einvests, as I mentioned, are actively managed so we tap into the investment expertise of the portfolio management teams. Vanguards, in the main ETFs, they are passively managed. You can go back to the slide that we talked about passive and actively managed funds. They do differ in rules-based and outcome-based, they differ in fees, they differ in teams, they differ in a number of different ways. You’d think that they are slightly different but they are, in saying that, ETFs. They are exchange traded funds.

 

Jodi Pettersen:

All right. I have another question here. Your fixed income funds are monthly distributed, how does that money end up in my account?

 

Camilla Love:

Yeah. Our fixed income funds do have monthly distributions as well as EIGA. Our einvest income generater fund. That money ends up in your account in … There’s two ways. Essentially, the coupons in the fixed income segment get paid as income and that then gets distributed into your account each month for shares, obviously they are dividends, and they get paid into your account. As I mentioned before, there is the dividend reinvestment or distribution reinvestment plan. Please, if you do want it to acrete to your holdings, add units to your holding, do select to participate in the DRP. If you do want to pay your distributions or dividends as cash into your account, you need to provide your bank account details and we’ll pay it. Keep an eye out on our website and through the exchanges. We do give you a number of dates that you need to know about, including the reinvestment price and a number of other bits and pieces associated with your monthly distribution.

 

Jodi Pettersen:

All right. Another question I’ve got here, Camilla, how do ETFs work with franking credits?

 

Camilla Love:

ETFs work with franking credits just like any other managed fund. They will pass through their franking credits as they pay their distribution and dividends. What you’ll do is you’ll get, in your tax statement at the end of 30 June each year, you’ll get a split of … The franking credits will be added into there and you’ll be able to see that quite clearly and you’ll give that to your tax advisor or you’ll put it into your tax return so it just gets passed through. For example, EIGA, I think it has a very, very high franking level, up over 80%.

 

Jodi Pettersen:

Fantastic. Well, I think that’s all the questions that we have for today. If you have any additional questions that you would love to ask us, on the screen right now, you can see our web address, einvest.co.au. Jump on there. There is a chat bot, you can speak to me, I’m the one who answers the chat bot. You can also go to our social media channels. There’s plenty of ways to reach us so feel free to ask additional questions and thank you again, Camilla, for joining us.