Are ETFs fueling the ASX bank rally or just enjoying the ride?

Exchange-traded funds (ETFs) are growing so quickly in popularity, both in Australia and globally, that it’s natural for investors to question their impact, particularly on price movements.

In the year to November 2024, the market cap of exchange-traded products (ETPs) on the ASX surged 42.5% to $235.6 billion, and many issuers believe $500 billion isn’t far off. But does ETF growth exaggerate the performance of stocks and sectors?

VanEck Australia recently tackled these misconceptions in a webinar led by Russel Chesler, Head of Investments and Capital Markets. “ETFs are often accused of blindly driving up prices, but in reality, active managers and market fundamentals are the real drivers,” he says.

Here’s a closer look at the most common ETF myths.

Myth #1: ETFs distort the market

The claim: ETFs indiscriminately buy stocks, distorting prices and driving rallies like the 35% surge in ASX financials this year.

The reality: ETFs don’t drive markets - they reflect them. Chesler pointed to the chart below, which shows how differently the top Australian companies performed earlier this year, as an example.

"Over the last 12 months I have heard so many times that the Australian banks, particularly CBA, are continuing to go up in value because of lazy indices that are just buying the market. If that were actually the case, wouldn’t all stocks in the ASX 200 be going in the same direction, up or down."

It’s worth noting that while CBA (ASX: CBA) has delivered 45% capital growth this year, Westpac (ASX: WBC) and other smaller financials in the top 200 like Bendigo Bank (ASX: BEN), Suncorp (ASX: SUN) and IAG (ASX: IAG) have achieved comparable or even stronger returns of 45-53%, according to Market Index data.

This challenges the idea that the biggest players should outperform simply because their size allows them to attract a greater share of ETF flows.

In the US, Chesler points out that despite booming ETF flows, only three companies - Apple (NYSE: AAPL), Microsoft (NASDAQ: MSFT), and Berkshire Hathaway (NYSE: BRK.B) - have remained in the S&P 500’s top 10 over the past decade. 

“Apple and Microsoft grew because active managers backed them. NVIDIA’s rise since its 1999 listing at $12 a share is also driven by active investors, not index funds.”

Key takeaway: ETFs are passengers, not drivers, in a market steered by active investors.

Myth #2: ETFs cause bubbles

The claim: ETF growth fuels indiscriminate buying, creating bubbles.

The reality: ETFs remain a small part of the total market. “In Australia, ETF assets have grown from $10 billion in 2012 to over $200 billion, but that’s dwarfed by the $2.6 trillion ASX market cap,” Chesler notes.

Globally, ETFs represent just a fraction of markets as shown the chart below, and bubbles are far more likely to result from speculative trading than passive flows.

Key takeaway: ETF growth is significant, but it doesn’t pose systemic risks.

Myth #3: ETFs don't function properly in a market crash

The claim: ETFs haven’t proven themselves in a real market crisis.

The reality: Chesler highlights that ETFs have proven resilient during periods of major market stress, including 9/11, the GFC, Brexit, and the COVID crash in 2020. During the onset of the COVID crisis, fixed income liquidity dried up as spreads widened sharply, as illustrated in the chart below.

"But fixed income ETFs, whether they were corporate bonds, high yield or treasury bills, continued trading. Pricing, while often at a discount to the holding price of the underlying bonds or fixed income instruments, became the market discovery tool."

Key takeaway: ETFs have become an invaluable price discovery and liquidity tool for investors, especially during crises, whereas off-market assets are much harder to value and trade.

Myth #4: ETFs create ownership concentration

The claim: ETFs lead to unhealthy ownership concentration in certain stocks.

The reality: While large passive managers hold significant stakes in ASX companies, their ownership is overstated, according to Chesler.

“The top three passive managers own around 17% of the top 10 ASX companies - but active managers and individual investors own far more."

Key takeaway: Active managers remain highly influential, and ownership is broadly diversified.

Myth #5: Passive managers are passive voters

The claim: ETF providers neglect corporate governance and stewardship because their role is to be passive managers.

The reality: Chesler explains passive managers like VanEck actively engage with companies, leveraging their influence and environmental, social and governance (ESG)-focused proxy voting guidelines to vote on thousands of management proposals by listed companies.

"As an example, we recently voted against the remuneration report for listed property giant Dexus because we felt the number of one-off bonuses was too high."

Key takeaway: Passive management doesn’t mean passive stewardship. ETF providers play an active role in governance, often aligning to good ESG principles.

Myth #6: You can’t outperform with passive ETFs

The claim: Passive ETFs limit investors to market returns.

The reality: Smart beta ETFs offer a step up from traditional index-tracking funds by combining the cost efficiency, transparency, and liquidity of passive investing with active-like performance.

“Smart beta sits at the intersection of active and passive management. It combines the best of both worlds - low costs with the potential for outperformance.”