HNW investors use ETFs to complete portfolios

The widely recognised poster child for ETF adoption in Australia has been young self-directed investors who are starting their investment journey. But this hides the reality of the growing proliferation of ETFs across portfolios of all types of investors, from those getting started to large institutional investors and everything in between.

In Australia, ETF adoption largely started with SMSFs seeking exposure to harder-to-access asset classes, such as international equities. Fast forward, ETFs are now a mainstream investment vehicle with 2 million investors in Australia holding ETFs in their portfolio, up from 1.9 million last year – a growth of 7% year on year. This growth has pushed the Australian ETF Industry past $196 billion in assets on the latest numbers.

As part of this growth in ETF adoption, the story that has been overlooked is the trend of private banks, wealth firms and family offices increasingly turning to ETFs to cater to the needs of their high-net-worth (HNW) clients.

Globally, this shift has been underway for a while with the HNW investor segment being one of the largest adopters of ETFs due to their liquidity, transparency, delivery of stated outcomes and low costs.

In Australia, as the HNW segment continues to grow with over 600,000 investors controlling nearly $3 trillion in investable assets we are seeing the same trend as experienced overseas.

Astute HNW investors are increasingly using ETFs in their portfolios to access strategies such as sector-specific exposures and enhanced indexing methodologies.

Convenience

Investors big and small are gravitating to ETFs for their convenience. As part of my conversations with clients, there is a growing trend of chief investment officers (CIOs) and their research teams from private banks and wealth firms to use ETFs to express a house view and pivot quickly.

With the recent tailwinds in regions like Japan and India, we have seen CIOs choosing to access convenient exposure to these regional equities with ETFs, rather than through unlisted active funds or a mandate structure.

More widely, whether it is a view on clean energy, robotics or a particular region or sector, with ETFs, CIOs can deploy their capital to asset classes rapidly where they see opportunities.

Further to this, while ETFs were once known for being broad market passive covering vanilla exposures, the ETF industry has grown to offer a greater array of portfolio completion strategies covering fixed income, equities and other assets.

For example, the growth of ETFs now allows a CIO to make surgical allocations to fixed income and target a certain duration, credit exposure or pick exactly on the yield curve where they want their advisers or their discretionary portfolio management team to invest in.

At Betashares, our Fixed Income Portfolio Management team and Investment Strategists are also a valuable resource for HNW firms to discuss ideas and optimise investment strategies for their portfolios.

As well as surgical allocations to fixed income, ETFs have made it far more convenient to access commodity exposures like gold within HNW portfolios. For example, CIOs have been able to use gold ETFs to capture the steady rise in the gold price over the last 12 months.

We saw a similar story during Covid with oil ETFs when the price of oil dropped to zero amid the early days of the pandemic. These commodity ETFs give CIOs far more flexibility to gain exposure to commodities that are typically harder to store.

Accessibility

The growth of ETFs beyond broad-market vanilla exposures has also extended to include growth in the number of intelligent solutions that allow HNW investors to target certain factors.

In this space, investors were once limited by choice to active managers who have shown time and time again the challenge of outperforming benchmarks, particularly after fees.

The SPIVA reports, published by S&P Dow Jones Indices tell a remarkably consistent story.

In the Australian market, the most recent data show that 77% of ‘Australian Equity General Funds’ underperformed the S&P/ASX 200 in 2023. This was the second-worst result for active managers since the beginning of the data in 2009.

Looking at longer timeframes, the story is similar. In every category with a 10-year history, 75% or more of the funds underperformed their benchmark.

Nowadays there is more opportunity for investors to build portfolios around intelligent exposures on a more cost-effective basis. Despite the flashy name, enhanced indexing is simply any passive investment strategy that uses some measure other than market capitalisation to determine weightings in a portfolio.

By breaking the link between the price of a security and its portfolio weight, an enhanced indexing approach seeks to overcome the pitfalls of traditional indices while retaining the advantages of passive investing.

One alternative for seeking a return premium or exposure beyond just the broad market beta is actively managed funds that employ so-called ‘style biases’, such as structural overweight exposures to companies with high profitability or low price-to-book ratios.

These active managers will often highlight the importance of their unique expertise, research process and security selection in constructing their investment portfolio.

Over the last twenty years, a whole new field in indexing has developed around factor or smart-beta investing. And it turns out that factor investing targets the same risk premia that many active managers have long relied on.

Investors can now get exposure to these risk premia through lower-cost funds that seek to track a rules-based factor index.

Regarding active managers that pursue a style bias, we have observed the following:

• Often, any ‘outperformance’ above broad market beta is in fact partially or fully attributable to a factor exposure rather than the manager’s stock specific bets (i.e. true alpha).
• The management costs of rules-based factor index ETFs are generally far lower than active funds.
• Over longer investment time horizons, rules-based factor index ETFs have tended to outperform the majority of active funds with the same factor or style bias on a net-of-fee basis¹.

What is perhaps less appreciated is that certain investment styles pursued by many actively managed funds are available through more cost-effective index funds, avoiding the need to pay high active manager fee loads.

Cost-effectiveness

In that same vein, the rise of ETFs has allowed HNW investors to focus on reducing costs within their portfolios.

Cost efficiencies are just as important to a HNW investor as they are to a retail investor. As HNW investors are focused on performance net of fees, index-based investment solutions can play a crucial role in a portfolio.

Gone are the days where paying an underperforming active long-only Australian equities fund manager 1% is the only option. These days investors can pay far less for exposure to Australian equities, whether it’s a market cap-weighted fund or something a little different like targeting a specific factor.

Because ETFs either aim to simply track the performance of an index or asset class or follow a rules-based methodology, there are no in-built ‘active management’ fees to worry about and can free up investible funds for more expensive investments such as private assets.

Best-in-class execution

In addition, with the growing scale of the ETF ecosystem, more efficiencies in execution can be achieved through the elements of the capital market chain, which in turn benefits institutions like private banks.

The Betashares Capital Markets Team works alongside the various market participants, including market markers, authorised participants (the institutional brokers that trade directly with Betashares) and platforms and executing brokers to ensure markets are effectively made in Betashares funds.

For example, limit orders, particularly for large orders, allow for price control and act as an important safeguard against overpaying, for example, by the order being matched at a price over and above that of the market makers.

ETFs are inherently liquid investments tradeable minute by minute on exchange and reflecting the liquidity of the underlying investment. As such, the goal of the capital markets process is to ensure clients realise maximum liquidity and minimise spreads and market impact costs to achieve the best possible outcome for investors.

Conclusion

While we have seen an incredible uptake in the use of ETFs amongst private banks for their HNW clients, the growing adoption of ETFs amongst HNW investors is just beginning in Australia. We believe that it will continue to become more mainstream amongst the sector.

Driven by convenience, accessibility, and cost-effectiveness, ETFs have become an integral tool for private bankers to use in their toolkit to meet the unique needs of HNW investors.

Source:

1. Based on a comparative analysis undertaken by Betashares of the performance of selected “quality” and “value” active funds to Betashares funds which track an index of the same factor over a five-year period to 30 June 2023