Your most-asked ETF questions answered

There are so many things in life that remain unanswered: how to cure hiccups, why time runs in only one direction, why there is only one word for thesaurus.

However, there is one thing we've been able to bring to light: all your questions on exchange-traded funds, or ETFs. 

From liquidity and management expense ratios to the benefits and disadvantages of using passive and active funds. This thematic episode of Buy Hold Sell hopes to answer some of the market's most common queries and questions on ETFs. Livewire Market's Bella Kidman is joined by the ETF experts; Shaw and Partners' Adam Dawes and VFS Group's James Whelan, to help join the dots on these investment products. 

You're welcome. 

Note: You can watch, read or listen to the discussion below. This episode was filmed on 31 March 2021.

Edited Transcript

Bella Kidman: Welcome to this thematic discussion brought to you by Livewire Markets. My name is Bella Kidman, and today we're going to be discussing the hottest thing on the market. Your kids are buying them, your parents are buying them, even your grandparents are interested in buying them. We're of course, talking about exchange-traded funds, also known as ETFs. And to help to answer all of your burning questions, I'm joined by James Whelan, from VFS Group and Adam Dawes, from Shaw and Partners. 

Adam, I'll start with you, you're right in the thick of ETFs, what would you say is the most frequently asked question you get?

Adam Dawes: The most frequently asked question I get is, how do I buy and sell ETFs? Well, they come to a stockbroker to do that. But then also they ask about liquidity and that's a big issue. How am I going to get in and how am I going to get out, basically.

Bella Kidman: James, you're also in the thick of it, what would you say is the most frequently asked question?

James Whelan: The most frequently asked question is the first few words of, "... is there an ETF that for X?" Everyone sees an idea, reads something, hears something, notices something, and they want to know if there's a way that they can package it. Is there a package that is readily available, that they can go into the market and be able to buy and then sell it as an investment. That's where the thematic stuff really comes in and there are some amazing ones that are out there, but that's the most common question I get.

Bella Kidman: Well you see ETFs every day, could you pinpoint three things for us that you think every successful ETF has?

James Whelan: The main question that I have for a potential ETF is, "is this smarter than me?" That for me, is a successful ETF, because something is only as successful as it being better than what I charge people to do. That for me is first and foremost. If this ETF is an active ETF, for example, that is run by people who are better stock pickers than me, and I'm not a great stock picker, so that's not very difficult to do. But if that is the case, and the answer is yes, then that's a successful ETF.

Bella Kidman: Adam, what would you say the three key factors that you think every successful ETF has?

Adam Dawes: Basically, if you're looking at the index, what do you actually want to get out of the ETF, and then looking at the index, does it actually match what it says on the box or on the package. So for example, if you're looking at a high active ETF and it's got an index of bonds, it will always beat that index. So you really should lift the bonnet a little bit. I think managers are definitely key in that space. And then again, it comes down to the provider, is the provider going to be around in the next 10 years? So we have seen a lot of cancellations of ETFs, so you've got to be careful who you're buying from and just lift the bonnet up a little bit on some of those ETFs.

Bella Kidman: A key concern that a lot of people have about ETFs regards liquidity. We spoke about it a little bit before. So why is an ETF being liquid, important? Is it important and do you look for it when you're considering an ETF?

Adam Dawes: Absolutely. The reason is we've all seen huge market falls - let's say the Covid crash in March 2020 or the Global Financial Crisis. The best thing about ETFs is that the market makers are there in the market for 80% of the day. But there are periods when they're not in the market. And if you don't have the market makers in there, they're not going to be able to provide the liquidity. 

Now also, the other side of it is, if I want to get out, I might not be able to get out at the price I want, but I will be able to get out of it. And sometimes when you've been stuck in a stock or something where there's no liquidity, you could be sitting there for months. With an ETF and market makers in there, that liquidity is really important and at least I'm going to be able to get out on the day for that client.

James Whelan: Quick tip, don't muck around with ETFs in the first half-hour of the day. I can't stress that enough. You were mentioning liquidity, that first half-hour, anything could happen. People at home, moms, dads, grandpas, kids, just don't touch it in the first half-hour, liquidity is just not there.

Adam Dawes: Or why buy an ETF that's ASX: IVV, that's the US S&P 500 at 10:00 AM on the Australian market, when the futures market and even the American market is not even open? Wait till two o'clock in the afternoon when the futures market is open in the US and then you get a better price.

James Whelan: Take some of the risk off the table as well.

Bella Kidman: I'd be getting your pens and papers out here!. James, what would you think, when the market crashes you want to get out, obviously.

James Whelan: When the market crashes?!

Bella Kidman: If the market crashes, you want to get out, is liquidity important for an ETF?

James Whelan: For sure and certain it is. It's funny, and as Adam was saying, single stock liquidity will just dry up and it's amazing what happened. Look at what happened in March, 2020, when physically people couldn't trade, couldn't muck around, couldn't do anything, there was absolutely no spread that was going on in anything like that, be aware that that can happen in anything that you're playing with. With ETF's, there's a little bit more assurance that actually there's going to be someone on the other side, when you need to liquidate, if you need to liquidate, you don't need to liquidate.

Bella Kidman: Sure. Well I love ETF's as much as the next person, but something I really struggle with is differentiating between providers. Especially with something like an index fund, you've got iShares that offers an ASX 200, you've got BetaShares, You've got Vanguard. So how do you differentiate between all these providers that are offering very similar products?

James Whelan: For me, it's really accessibility and the information that I can get from them. Apart from the obvious ones, like size, reputation, reputability, how much backing you've got behind you, that's all a given, as far as I'm concerned, that should just be a part of it. It's the accessibility for me! If I want to know something about an ETF, I want to be able to pick up the phone to the guy, to the girl who's there and have them know what they're talking about. "James, I've got some great ideas for you. You're looking for this information. Here's some information, we'll be able to walk you through it." That's exactly what people pay me to do and that's what I expect from my provider.

Bella Kidman: Adam, same question to you.

Adam Dawes: Yeah. MER, I think, management expense ratio. If you've got all these providers and it's a passive ETF and it's the ASX 200, why would I be paying 20 basis points when I can pay seven basis points. And we know fees are a detractor from performance, so you really should look at that MER, take an understanding of what's going in and sitting underneath it. And potentially if it's lining up against three different index ETF's check the one that's got the lowest MER and that would be one of my choices for that.

Bella Kidman: Okay. Well, now we know what an ETF is, maybe can you explain to me the difference between an active and a passive ETF and why that's important when you're considering one?

Adam Dawes: Well we just talked about rockstar fund managers or people that can pick stocks better - well, maybe not better than me, but anyway -  better than a lot of other people. But look, certainly ETF's, an active ETF is a manager that can take advantage of movements in the market. They're only constrained by the index that they're playing in, and they can be overweight, certain sectors, underweight, certain sectors, and they basically can be acting inside of that ETF. Whereas a passive ETF is just basically an index, let's say the ASX 200 and they have to use that and they have to go within the weights of the banks, the resources, and it has to stay within the line. So that's passive and you pay less for a passive etf and you pay more MER again, for an active manager.

Bella Kidman: James, are there pros and cons of active versus passive?

James Whelan: It depends on the time that you're actually investing in and what part of the cycle. For example, now I want to be in something that's a bit more active because the market is a bit choppy, it's a bit volatile. There's a rotation potentially going on right now from growth to value. I want to be in an ETF with a manager that could pick that and be able to be ahead of it. An index hugger might miss out on this. So it depends on what part of the cycle you're in.

Bella Kidman: Another question a lot of investors have are the difference between an active ETF, like what we've been talking about and an LIC, so a listed investment company. Can you explain the difference between these two?

James Whelan: Put really simply, when you buy an ETF on market, you're owning that fund and then you're in effect owning all of the holdings that are underneath. With an LIC - I like that Adam was nodding his head, it means I'm getting it right! - with an LIC, you're buying that company, and not the underlying assets of a single fund. So it's a little bit different in that way. If you like a manager, you'd buy an LIC because you can see they're undervalued, but if the ETF is more of a theme that you're moving in, then you'd look towards that ETF.

Bella Kidman: ETF's, LIC's, lots of abbreviations, Adam, what would you pinpoint as the main differences between these two?

Adam Dawes: Really its the market maker. In an ETF, there's a market maker which is what is called the NAV, or the net asset value. With a LIC, there's no market maker in there and hence, LIC's can trade above their NAV or below. So sometimes you might, not looking as an inexperienced investor, might buy above the net asset value and then obviously it starts to come back or you can see some discounts in there. So the market maker in an ETF, make sure that it sits around that NAV most of the time. And that's what I like, I don't want to be paying over, or I don't want to be paying under, I want to make sure that I'm getting the right price for my clients.

Bella Kidman: Okay. Well, I'll throw another one in there, MER, management expense ratio, so that's obviously fees. How, number one, does an investor pay an MER on an ETF, and also, is that an important consideration?

Adam Dawes: Yeah, look definitely an important consideration, we talked about that before, being that's trying to find, I guess, the cheaper ones in an index or a passive ETF, I think that's fair. With the active ones, you're probably paying a little bit more fee, MER, so that's, I think, is fair as well. I always thought that the MER was inside of the spread in the ETF, and when I was doing my homework for this show, I actually found out that it wasn't. It was not inside the spread because that's where the market maker is, it's actually in the management fee that's inside the fund. And they will minus it, the management fee, let's say it's 10 basis points, off the fund on a daily basis, and it's also done on a pro-rata basis as well. So if you're only in the fund for the last one month of the 12 months, you only pay one 12th of the fee. So it's actually been quite well set up for investors.

Bella Kidman: MER, important, not important?

James Whelan: Yeah, it's pretty important, how much you're actually going to pay and for an investor, taking into consideration with what it is that you're doing. If you've got to pay the brokerage, or if you've got to pay a service fee that you have to, imagine also that you need to pay this one on top, which is deducted, I always thought monthly, but there you go. Anyway, it's calculated daily, deducted monthly, off the ETF and that just comes straight off the price of the ETF that's there. And that's something that you need to take into consideration too, is what you're going to have. If you like a really good active manager, that's good, but be okay paying up for it, but just take it into your overall costs.

Adam Dawes: There's only one ETF that I've seen, PM Gold, they actually take units off clients at the end of the year for their fee. So we've had these unhappy clients that had 1,000 of these ETF shares, and then all of a sudden they've got 990, and they're sitting there going, "What's going on?" And then we had to go through the PDS and actually look at it, and that's how they take their fee at the end of the year.

James Whelan: Is that because it's physical gold?

Adam Dawes: Yeah. And so you got to be careful when you buy.

Bella Kidman: Fair enough. Well, James, there's been a lot of crazy activity in the market, we've seen GameStop surge, we've seen Bitcoin rise and ETF's are really looking to take advantage of this. We've seen the BUZZ ETF, we've seen the FOMO ETF. So what would you say some of the risks when getting involved with thematics like this?

James Whelan: I've got this little idea that's in my head, which is that you've got a BUZZ, you've got a theme, you've got some sort of a fad. And if you can ride that, usually by the time you hear it, you're going to be the last to know and you might just be the last bag holder left at the day. When a fad becomes an actual theme, is in my belief when a government gets behind it. The example that I would say, probably Bitcoin might be one of the most recent examples, but let's just say medicinal marijuana, so your cannabis stocks. That went from being a fad, everyone's going to be doing these amazing things, to all of a sudden the US government says, "We're going to start legislating and taxing it." Great, that's not a fad anymore, that's now a theme, that's now an actual investible idea. That's when that changes. So if you want to be in a theme, just try and make sure the government's behind it before you really charge in.

Bella Kidman: Who would have thought we'd ever be investing in FOMO? What are some of the risks that you would tell investors to be wary of when investing in these sort of themes?

Adam Dawes: Look, there's certainly themes and the FOMO theme, the BUZZ theme and all these kinds of things are certainly themes. And I think that's the issue with this, is that a lot of ETF providers actually take time to get these products onto the shelf and out to the market, and sometimes that's six months and potentially, that could be a little bit too late. So potentially you might be holding the bag on something that potentially, like the marijuana sector, certainly everyone got excited, but then it all fell away as well. So I'd just be really cautious about the buzz words or the buzz ETF's that are out there, because potentially they won't last as long as you expect.

Bella Kidman: Well, what are you waiting for? It's time to jump into the ETF investment universe before you get FOMO. If you've enjoyed this episode of Buy, Hold, Sell, make sure you subscribe to Livewire's YouTube channel for more.

Do you have any other ETF questions for Adam and James? 

Let us know what questions you have in the comment section below and we will get Adam and James to answer them. 

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