End of financial year thoughts on ETFs

Sir Benjamin Franklin had some witty quotes: one of my favourites is: “Beer is proof that God loves us and wants us to be happy.” 1 June marked the day pubs re-opened in New South Wales, and the beers started to flow from the tabs at pubs/bars and happiness started to flow in our faces as we begin our journey back to at least some normality.

Whilst our headlines have been dominated by Covid-19 and U.S. political turmoil, in markets, Exchange Traded Fund (ETF) inflows have continued to run at full steam ahead of last year’s flows, with US$143.7 billion flowing into global ETFs in the first five months of this year¹. For reference, inflows from 1 January to 31 May 2019 were US$68.1 billion.

Investors of all types have continued to embrace the key benefits of ETFs – transparency, diversification, lower cost, and tax efficiency – to express their investment views. ETFs have democratised access for all investors, and their tax efficiency brings an additional benefit relative to other investment vehicles such as traditional managed funds, as ETF investors can have greater control of their own taxation outcomes and are not necessarily impacted by other investors’ behaviour.

In an unlisted managed fund, when an investor wants to redeem their investment, the fund manager may be forced to liquidate some of the fund’s underlying holdings in order to fund the redemption, in the process realising capital gains or losses. The taxation consequences of these gains and losses are typically borne by all remaining investors in the fund – and not the investor who is redeeming their holding.

In contrast, an ETF investor exits their investment by selling on market, meaning that there are no taxation implications for other investors, as the ETF manager does not need to sell underlying assets of the fund in order to pay out the exiting investor. The investor who sells their units bears the taxation consequences in the form of the gain or loss they make on the units they sell. In addition, to the extent that large financial institutions (called Authorised Participants) redeem their units directly with the ETF, any taxable gains realised by the ETF to fund the redemptions are normally borne by the redeeming unitholders, and not by other investors.

30 June marks the end of the financial year for Australians, and also marks the time when many investors are reviewing their portfolios to assess the health of their holdings.

Investors looking to divest away from securities that have dropped in value, but who do not want to move to cash given the current low-yield environment, might consider using an ETF to achieve more diversified market exposure.

For example, say an investor holds shares in one of the big four banks. The financial sector has been hard hit in the Covid-19 crisis, and WBC, NAB, CBA and ANZ have all suffered heavy falls, as the chart below shows.

 As both the chart and the table below show, there has been some variation in the extent of the falls across the four banks.

Table 1: Big four banks, share price falls YTD

One option for the investor to reduce the stock-specific risk of holding a single banking stock may be to switch their financial sector exposure to the BetaShares Australian Financials Sector ETF (ASX: QFN).

QFN can help the investor achieve a broad market exposure across the financial sector, providing diversification benefits, rather than exposure just to the one bank.

In addition, any capital losses that may arise from switching into QFN from a direct holding in one of the big four banks before the fiscal year-end may potentially be used to offset any gains from other shares sold when the market was riding high. Obviously, the taxation implications depend on each investor’s individual circumstances, and this is only one potential outcome. You should consult your taxation adviser for advice on your own taxation circumstances.

Similarly, investors with direct holdings in one of the resource giants could consider the diversified exposure offered by the BetaShares Australian Resources Sector ETF (ASX: QRE), while holders of Australian technology stocks now have the option of investing in a portfolio of Australian technology leaders via the BetaShares S&P/ASX Australian Technology ETF (ASX: ATEC).

Investors with direct holdings of internationally-listed stocks could also consider using ETFs from our international range of funds.

We could all use a celebration, and EOFY is as good a reason as any. So, as Ben Franklin would say – cheers!

Note: BetaShares is not a tax adviser and this information should not be construed as tax advice. You should obtain professional, independent tax advice before making any investment decision.

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ETFs are one of the fastest growing investment vehicles in the Australian market. For a full range of products available to investors, please visit BetaShares website.