ETFs are gaining popularity, but what makes an ETF a good investment? Anthony Arthur, Head of iShares Asia ex-Japan Wealth Distribution of BlackRock and Freddy Lim, Chief Investment Officer and Co-founder of StashAway get to the heart of all things ETF.
Philipp: [00:56] Hello and welcome everyone to another episode of In Your Best Interest. Today, we have a fantastic topic to chat about and I’ve got two fantastic guests with me as well. Today we will be talking about ETFs. That stands for exchange-traded funds. It's an investment vehicle that's gaining a lot of steam across Asia as well, after already being very successful in the other parts of the world. For that topic I have with us today, again, our Chief Investment Officer, Freddy Lim, who is obviously quite knowledgeable in that space as well. At StashAway, we also make use of ETFs in our portfolios. So hey, Freddie, good to have you back.
Freddy: It's my pleasure. Yeah. Hello.
Philipp: Good to have you. And from outside of StashAway we have actually with us someone from BlackRock. His name is Anthony Arthur. He's the Head of Asia ex-Japan Wealth for APAC at iShares which is the ETF side of things from BlackRock [02:00], and he's been with them since 2013 I think Anthony?
Anthony: Yeah, that's right. Thanks for having me. I'm delighted to be here.
Philipp: It's really good to have you. We are really looking forward to that discussion, because especially in Asia, the topic of ETFs is still emerging. We usually get a lot of questions about it. I, personally as well, from friends. Having lived in the US for 10 years almost and seeing the rise there since the financial crisis, pretty much has been fantastic to see because it gives a lot of people access to low-cost investment products with great diversification, which we will dive in here. So, how about we do that, Anthony? Get some people that come on the podcast. We like to not interview you, but we would like to get a little bit more background knowledge because I think people are always super interested to learn more about our guests. We get some younger audience that look up to people, “Hey, what path should I take after university?” or the first few jobs that they have. So, just to give the audience a little bit of your background, can you tell us a little bit about yourself? Maybe where you grew up? Where you went to university? Did you study finance, maybe?
Anthony: Sure. I'm actually from the UK. I grew up in London. I went to London University, though I did have a spell outside London in a boarding school in Yorkshire, which is in the very North of England. I moved to Asia in 2012 and started working with BlackRock not long after that. I actually didn't study finance. I studied ancient history.
Anthony: It was quite a niche degree. But it stood me in good stead and I think the lesson from that is you pick up skills through [04:00] studying a degree which is not necessarily purely based just on the content that you learn.
Philipp: No, absolutely. Was there anything that sparked your interest through studying? Or, maybe early on in life already to then get into finance? Because when I did my first internship at an asset manager during university, there were actually a lot of the investment banking analysts there that came from a lot of liberal arts schools in the US. History was a lot of times actually the major that they studied, but they ended up in finance. Some people were pretty straightforward. They said, “Hey, this is where the money is”. Others were inspired by people they grew up with. For you, when did you make the decision to say, “I want to go into finance”?
Anthony: I actually started out working for a communications agency that looked at consumer goods. I got a little bit frustrated with the depth or I felt that there wasn't enough depth in that. And at the same time, a friend of mine who, as you say, is a liberal arts student, he had a first in English, became a fund manager. Through talking to him, I thought this is the sector that I want to be in and I made the shift a couple of months later.
Philipp: Okay. This is always interesting to see but I think it shows again, Freddy, that no path is always just a straightforward one that you plan for when you go into college. We had with you, the other guests before as well. It shows that you just navigate the circumstances.
Freddy: I'll have to second the observation. When I first started at Lehman Brothers back in the year 2000, a lot of guys [06:00] were Harvard Law School or Art school or Political Science. None of them are doing quantitative finance, right?
Philipp: Yeah. So, I asked him when I started the internship I was like, why did they get hired? Obviously, they went to mostly Ivy League schools. So people knew they were smart, they can do math. I think a lot of the hiring managers they just went with the smarts and people are being, obviously, they have to be good at studying and stuff to get into these schools. I think they just saw the talent and then they made them all get their CFAs usually. And then on the job training. This was usually the case but good, thanks Anthony for giving us that overview. One other question that I always like to ask is, what is the best investment you ever had, you ever made?
Anthony: I was thinking about this the other day, actually. I invested in a sustainable fund when I did my first pension selection at the very start of my career, which was early 2000s.
Philipp: Wow, that's early on for sustainable funds.
Anthony: Yeah. Actually I had a client that did sustainable investing at the time. The fund itself has been okay in performance terms, but what I like about that is that, I just think sustainable investing is going to be like recycling. It's the new normal, is what everyone will do eventually. And we saw there's some research out recently actually by Nordea, the Swedish bank. They said that if you move your savings into sustainable funds, it'll be 27 times more efficient for your personal [08:00] carbon footprint than eating less meat, using public transport, reducing water and flying less all combined. I really think that the power of sustainable investing is enormous.
Philipp: That's super interesting. I didn't know that the number would be this big, and this should be more publicized. Because people want to be more sustainable in the way they live, right?
Anthony: Yeah, I think it depends on markets. You can see in Europe for sure, in Australia it's taken off and I think it's big. There's beginning to be greater awareness across Asia as well.
Philipp: Yeah, super good. But you mentioned so you use this in one of your pension funds, right?
Philipp: I think I want to shift over to ETFs and get an overview of the history there. But when you talk about pension, this was the first experience I actually had with ETFs as well. It was in my first role with Morgan Stanley in a 401k plan. So basically the US equivalent of a pension plan, where you make your own decisions, and they had a lot of choices in terms of to invest at Morgan Stanley and some of them were ETFs, which was the first time I really got exposed to them. But most pension funds still don't really have a lot of ETF choices. So, it's usually still mutual funds as far as I can tell. Do you have any insights on that?
Anthony: Yeah, you're right. The available selection that I could choose from in that pension plan was purely mutual funds. Some of them were trackers, but they were all mutual fund rather than ETF-based.
Philipp: Or at least they already had trackers in the early 2000s. So, that's actually not too bad then because I think a lot of time. It used to be also mostly managed the same for us as well. So the choices were always quite, you made a choice on an [10:00] investment manager versus let's say, a fund provider, in that case. But before we get into that, I do have more questions on that topic. You've been with BlackRock for quite some time. You had exposure to ETFs through them, through your own investment, before Freddy in episode one of this podcast, talked a lot about his exposure to that as well. Maybe both of you can talk a little bit about the history of ETFs. I think Anthony you will have also some great insights from BlackRock there in terms of where did they come from? How long are they about? Because where I want to get here is that in Asia, they seem they're the new thing. Still, people don't know about ETFs like at StashAway Academy we actually do a seminar every few weeks: How to invest using ETFs. And we actually show people what are ETFs? What you should look out for in investing in them. Because it's still so new. People don't know what they are. People here still buy a lot of managed funds with high fees and things like that. Maybe we'll talk a little bit about the history to show them actually that they're not just the newest thing just now. Not the last five years.
Anthony: Sure. Shall I go first just quickly?
Anthony: There's a bit of debate on what was the first ETF, but we always say that there was 1993 and there was an ETF launched on the S&P 500, which is still around today, that funds. But really the industry, I think if you look back the industry didn't really sort of gather steam, till really after the financial crisis. In 2010, there were only $1 trillion assets held in ETFs. That number today is just under $6 trillion. Even after, [12:00] the sort of sell-off that we saw in March this year. You can see a lot of that growth has come relatively recently, and I think the biggest drivers for that are costs coming down on ETFs have been a huge driver. In terms of what we see with Asian investors, and we look at Hong Kong and Singapore, we actually found that there was a dispersion in how people use ETFs according to their age bracket. So, if you're under 35, those investors, much more self-directed, perhaps more comfortable. The stereotype is that they're much more comfortable doing their own research on the Internet. They had a much higher prevalence for ETFs use than the 35 to 55 bracket, and then funnily enough, and we saw this is more pronounced in Hong Kong actually. But the over 55 brackets, over 60s typically invested in ETFs to a much higher proportion than their peers who're a little bit younger. That may be because they spend a bit more time at home, doing their investments. And some of that is perhaps ETFs are on exchanges and these investors are pretty comfortable trading stocks daily anyway.
Philipp: Yeah. I think that's a good overview. You did mention that one of the drivers of the growth is cost and efficiency of costs versus prior products available to retail investors especially. And maybe Freddy, you want to go into this. Can you explain a little bit more about what cost means when you talk about investing in ETFs versus what else would you invest in? Let's say, for example, unit trust or mutual funds?
Freddy: [14:00] Well, we can take count of the obvious but we also need to consider what's not on the fact sheet. So, to start with what’s visible, if you start with the expense ratios which is what the fund manager’s charge for managing the funds. However, the expense ratio actually does not include any distribution charges that may or may not be there with respect to the fund. But in the case of ETFs in general, there's not a lot of distribution charges outside the expense ratios. But you also need to look at stuff that was taken out of your NAV, your Net Asset Value in the fund, which comes from trading operations, how efficiently an ETF is managed or not. A way to look at that is to see how the ETF behaves versus the underlying tracking index. And if you tend to see a wide tracking error that tends to tell you there's a lot of other stuff going on. Either the fund manager is doing a poor job, or there are some other charges in their daily operations. So there's a lot of stuff outside.
Philipp: I think that's a good question, Freddy here. Actually a good observation that is confusing to a lot of people. Maybe Anthony, you can chime in on this as well as Freddy mentioned the tracking error. People always say, before you invest in ETFs, you need to look at tracking error, and not every ETF is the same. If something is tracking the same thing, why is there a tracking error? Why is one better than the other? Like if I'm tracking the S&P 500 and the other ETF is supposedly tracking the S&P 500, why does one have a bigger [16:00] tracking error versus the other? I think for a lot of people that's a very confusing topic.
Anthony: Yeah, I think Freddy really hit the nail on the head really. That's a very important thing to look at. But it's also an indicator that perhaps there's more going on underneath the surface of the ETF. One example might be that it could be a synthetic ETF. What do we mean by synthetic? It means that it achieves its exposure through derivatives. If it was tracking the S&P 500, it would give you a replication of the performance of the S&P 500 instead of actually owning the underlying shares in the S&P 500 itself. That could be one reason and often there'll be counterparty charges and perhaps counterparty risk that you need to be aware of when you're looking in something like a synthetic ETF. Another reason might be that the ETF is trading in a different time zone to the markets that it represents. For example, if you were to buy an ETF that's listed in the US, but is trading Asia, the US market is open when Asia is asleep, so there's going to be a disconnect between when the stocks that trade within that make up the constituents of the ETF, they're trading at a different time to the ETF itself.
Freddy: I guess also adding to what Anthony has said, there are also reasons like the replication methods being different. For example, some asset class are not exactly like the S&P 500 where everything is reasonably liquid to own physically. Some funds may go for something called statistical sampling where they don't own everything in the indices, but they sample from it in such a way that [18:00] statistically get close to what the index is doing. Because of that approach, maybe the expense ratio can come down, but the tracking error could be widened, depending on the underlying nature of the market. So there's a lot of possibilities there.
Philipp: That's good. I think that's a great insight there on the costs but also that not every ETF is equal in terms of when you're scouring for one to invest in. So, we talked a little bit about where ETFs came from, we talked about the cost, how else are ETFs used in today's world? Are they mostly just used to just by retail investors to invest instead of a mutual fund because they see the mutual funds managing US large-cap equities cost me 1.5% a year, but I can just buy an ETF that costs me maybe 0.2% a year. Is that the only decision or is the only use today? Or are there other ways why they make sense for people to use them?
Anthony: Yes, I think ETFs are used in multiple ways. I think the most obvious one is someone saying, I just want exposure. And we've seen that over the last couple of months particularly where we've seen retail volumes for ETFs really spike up and what's driven that is just people are looking at what's happening in the market and want to make a quick tactical investment and to capture what they see as a possible return in the short term. But by far and away, the biggest driver for the ETF use is ETFs being used to build portfolios. We see that we have clients that are asset managers, they are ostensibly delivering an actively managed product. But they're using ETFs to do so. [20:00] Really, if you think about it, every time that you make a decision whether to invest in US equities or to invest in fixed income or Asian equities, each of those decisions is an active decision. But it's just that the vehicle you choose to express that decision with is a passive instrument. It tracks the index as opposed to seeking to outperform it.
Philipp: Yeah. Basically, you're saying that even asset managers as well as retail investors, let's say especially during this year, they say, “Okay, everyone is working from home, technology is going to be doing well probably because people still need to use technology”. Instead of then trying to figure out which company does well, they can just buy a tech sector ETF, correct?
Anthony: Exactly. And one of the things that have come through now is that the ability for ETFs to really drill down into a particularly niche or sub-sector is so much more improved from where they were a few years ago. That's really the advent of things like big data. So you've got companies out there that can look at supply chains for companies and then build a whole sub-sector that goes way beneath in terms of detail than the sectors that we're commonly used to for looking at how equities trade.
Philipp: Yeah. Freddy, Anthony was mentioning asset managers or fund managers making tactical choices by using ETFs for their portfolios, maybe you want to give a little bit of an overview of first of all, why did you choose ETFs to build portfolios and then what's your reason for allocating to certain sectors maybe?
Freddy: At least for the StashAway angle, our intelligence [22:00] is in building portfolios of different asset classes and around the world. For us, the easiest way, the most efficient way, and the most cost-effective way to do so today remain to use ETFs to do so. But there are also other situations where it's not necessarily better with ETFs. It could be with the unit trust as well. We are actually quite agnostic in that respect, but it just so happens today, by the numbers, by the expense ratio, by the tracking error, by the kind of offering, there are so many choices that are out there with ETFs now, that we felt compelled to use them.
That's the first thing I want to first clarify. But other than that, really, in our case, we are just interested in the tracking ones. We are not interested in smart beta or some of those that are AI-driven. We also like physical, we do not like synthetics, we do not like leverage, we do not like inverse, we do not like ETNs, which is the bond note disguised like an ETF with extra counterparty risk. We are quite selective actually, even though we use ETFs in general. So it's not like all ETFs are made equal and I think users and audiences should always do a bit more homework. Obviously, we have the likes of the big players like BlackRock and a few other counterparts that have a strong track record of managing ETFs for so long. So, the reputation of the fund managers come into consideration as well. [24:00] I would say a lot has come in between us and the regulators on how we use it, that the primary use is to just track the asset classes we want to track to construct those very diversified portfolios for StashAway clients.
Philipp: Yeah. You just mentioned diversification again. I think we learned earlier on that in the evolution and the way ETFs have come about, they can really help diversify people's portfolios. Maybe Anthony, can you give us a little bit of a rundown of the benefits for diversification in portfolios for even retail as well as asset managers, and why ETFs are helpful for that?
Anthony: Yeah, sure. Diversification has that old cliche with it. It's the only free lunch in investing but what that means really is that investors should hold multiple sources of return in their portfolios. And that's going to mitigate the risk that if one source of return, say the US equities, doesn't perform, the rest of your portfolio is perhaps shielded from some of that risk and can still deliver a performance when one asset class does not perform. So it should smooth out some element of volatility in your portfolio. How do ETFs help that? Well, the obvious and most basic level is that the ETF holds multiple stocks or bonds inside it. You straight away have some benefit of diversification just by holding an ETF, because you're not then exposed to single security risk. And then the next layer of diversification benefit is where you stitch multiple ETFs together to give you access to those different sources of return.
Philipp: Perfect. I totally agree. [26:00] I think Freddy this is what you alluded to that you're doing with portfolios for StashAway clients as well, right?
Freddy: Yes, absolutely. You need multiple pockets of return. I know psychologically for an investor when you log into your account, you look at line by line, right? That tend to be this psychological barrier, “Hey, why is this line item not making money?” Everything moves up -
Philipp: We always see this. Like how long people were upset about gold positions or certain bond positions, but then volatility starts picking up, right?
Freddy: Yes. I remember in our first major re-optimisation, a change in portfolio allocations back in December 2017, the markets were doing very well that year. Emerging markets were up 40 plus percent, technology the same. And StashAway has to go out there at the end of the year and say, “I'm buying a lot of Gold”. And people's first response was, "This is not going to make a return. It's not going to make income. What was wrong with you?" That was when gold prices were $1242. We're now talking about say $1700, right? So it's easy to look at the line items and forget the value that resizing something elsewhere other than return. It will provide you with that portfolio insurance in case something extreme happens tomorrow that you did not expect, right?
Philipp: Yeah. And I think it's true throughout time. I have so many friends that always come to me and say hey I can just buy the S&P 500 and just let it grow for the next 30 years. Why do I need a diversified portfolio and buy all kinds [28:00] of different ETFs that I then have to move around and things like that? What I always ask them then is, hey, if your portfolio is down 40-50%, like in 2008, will you still be able to hold on to that one ETF that you bought that is now down that much? No, just have to make people aware because that's the worst possible moment in time to sell. So if you are happy with it and you hold it for 30 years, yeah, go ahead. Buy that ETF. This is what Warren Buffett always says as well. Yeah, just buy the S&P 500 for life. But holding throughout that time is where investor psychology kicks in and I think having that diversified portfolio in the way Freddy has said that asset class sometimes are down, they work in other ways to insure your portfolio a little bit as well, it’s super important.
Freddy: Well, ultimately it comes down to the user's investment risk profile. I mean, if your risk profile, it happens to be exactly the same as the S&P 500. Maybe it's easier for you to just go and buy an ETF that tracks the S&P 500. In most cases, most of us are not, right?
Philipp: No. I've seen too many and after the financial crisis, the first job where people are calling in crying just before retirement because their accounts are down 40-50%. So obviously, a lot of people, especially after like 10 years of bull market people are just like they don't look back, they don't remember how bad it was. Like evaluation of your risk and your goals in life that you always preach Freddy is quite important for that.
Philipp: We've talked about a little bit of the diversification of ETFs. I think people can do some more research but I think a lot of the pros that we talked [30:00] about around ETFs are there. Anthony mentioned earlier, you can also get tracking mutual funds or tracking unit trust and you did as well Freddy. That you don't completely say, hey, we would never do that, invest in those. What are some of the pros and cons between ETFs and mutual funds/unit trusts? Especially, maybe they are also just tracking an index?
Anthony: Yeah. I mean, mutual funds and ETFs do have something in common, and that's they're both open-ended. I mean by that is that as more investors want to invest in the funds be that a mutual fund or an ETF, that funds can keep expanding. It's not constrained in size. But where they differ, is that ETFs are liquid and tradable during the day because they're listed on an exchange. And it's that point of access that really sets ETFs apart. Investors can access the investments that they want, as markets are open. Whereas it might take some time to subscribe or to sell a mutual fund holding. It could be that you will want to make a position in one day and sell it in the same day, you can do that in an ETF or if you wanted to buy something and hold it for the longer term. But the other most fundamental differences, for the most part, the vast majority of ETFs are passive instruments where they just seek to give the performance or they seek to track an index whereas typically, mutual funds are managed investments where they seek to outperform a particular index. Now, there's obviously cost comes into play for that because ETFs tend to be cheaper on a given exposure than mutual funds, and that can be limited for some mutual funds, because it means that not only do they have to outperform the index [32:00] that they're placed on, but they also have to give enough outperformance to cover the cost of investment.
Freddy: Yes, absolutely. On that point, it raises the bar for the active manager to make the same return. And in a market where everything goes up, there's not a lot of differentiation among the different stocks in the index, then the fund manager would not perform as well as the ETF that's tracking it in a very efficient manner. So this is a function of whether you get differentiation, whether things are different industries in the whole stock index, they are behaving differently, they're going differently or not. So in most cases these days, we don't see a lot of differentiation. It's been there for a number of years that you see, in general, the market return is a majority of the return of an asset class. In fact, I think BlackRock had done a study on that where you're shown that 96% of an asset class returned is actually due to the decision to allocate to it rather than to pick winners and losers.
Anthony: Yeah, exactly.
Freddy: I have various numbers lying around some people mentioned is 80% some people mentioned is 96%. But it's a big number.
Anthony: Yeah, I mean, actually we quote some statistics from Norges Bank, that Scandinavians again, they're looking at their portfolio and actually security selection is a relatively small part of the return, around 90% is derived just purely from selecting which asset class to invest in.
Philipp: Anthony, sorry that this just came up in my thinking that a lot of people might have questions about because we just talked about the [34:00] ETF versus mutual funds/unit trust debate and how they're managed. When you say that tracking an index, can you maybe because we have you on the line, say who actually manages these ETFs? Let's say I buy iShares, US equity ETF and it tracks the S&P 500 index in this case. Is it a computer program that just buys every time inflows or outflows, it just buys the 500 holdings? Or is that still a manager doing some part of the work?
Anthony: There's still a manager doing part of the work. And you mentioned the S&P 500, that is perhaps the easiest market to track because 500 of the largest companies in the world that have ample liquidity and in each to make up a unit of an ETF typically is going to hold 500 stocks if they're all trading. Where it gets harder, and Freddy mentioned this a little bit earlier is where you might have some sampling technique is if you're tracking a market that perhaps some of the stocks don't have a lot of free float, there's a balance to be made between, say, do I want 99 of the stocks of an index of 100 if it's going to cost more for the funds to go looking for that last stock, and then in doing so, perhaps the trading will be prohibitively expensive and be a knock-on effect on the performance of the ETF.
Philipp: Good. I think that's a very interesting topic because I think people never really understand it’s tracking something but how do they actually do it? So, thanks for giving some insight there. I think that will be super helpful for people. [36:00] So we talked about ETFs, why they're good, how they work versus mutual funds/unit trusts, before we get into how retail investors or any kind of investor actually can get better access to ETFs. We usually get a question. And I know Freddie has a big opinion on this as well. But even it came up again, I think earlier this year Michael Burry from The Big Short even from the movie and the book, famous for shorting the housing market in the crash says, “There is an ETF bubble, people are pouring money into these passive investment vehicles. Let it be open and closed-end, et cetera." And he thinks it's a bubble. You've been hearing this more, and more, it comes up every once in a while from the media. Would you guys like to dismiss all this or like demystify some of those concerns that people have?
Anthony: Yeah, sure. You're right. It comes up from time to time and someone will make a very strong statement that then spawns quite a few articles and more discussion on this point. Of course, we should look at all the risks in investment. But our reply to that is really, it's a question of scale. Equity ETFs, as of May this year are around $4 trillion in assets, but the total equity market is around $80 trillion in assets. A very small proportion of the overall is held in ETFs. To that point on there being a bubble, no one says that about active strategies or mutual funds which are around $20 trillion of [38:00] that market in equities. So, we think based on those numbers, there's actually quite a long way to go and we've seen where I think people talk about the risk of ETFs saying that either the ETFs are trading so much in a particular asset class, that they're causing additional volatility, or that there's so much trading related to ETFs that people won't be able to exit a position because there's more trading in an ETF than there is in the underlying market.
We did some analysis on that. An ETF needs to grow or reduce in size needs to be you create or redeem units, it's what's called. And that's whereby you'd collect a basket of 500 of the S&P 500 and build a new unit. But that's really where the ETF touches the underlying market because that's where you need to go and find new stocks or sell stocks to break up a unit. We found that for the S&P 500, that ETFs account for really just 3% of trading in the underlying stocks itself for the primary market. Which is a relatively low proportion. People often raise this issue for fixed income particularly because most bonds don't trade on an exchange, they're traded over the counter. And people are often asking, well, how has an equity-like vehicle like an ETF that trades on an exchange and has daily liquidity, how does that match with an asset class that is not trading frequently like that? [40:00] Look, fixed income ETFs are regularly tested. But what we've found is that where we have periods of market volatility, is that actually we see trading increase in fixed income ETFs and each time that trading level increases, it's with higher numbers. We saw that again, most recently in the market volatility we saw over March. If ever there was a time when there was stress in fixed income markets, that was it, and ETFs were tested and we'd say that they came through that period pretty strongly and passed that test. Actually, the Financial Times wrote and they have been a long-standing critic. The ETFs-holding bonds played a key role in easing the March turmoil. That's really an about-face by the FT on that topic.
Philipp: Freddy, I know you have usually lots to say on this topic as well, because you get that question quite a bit, right?
Freddy: Yes. Adding to Anthony, I would say that why bring the smaller guy in the market for systemic risks? In the sense that global ETFs assets under management globally, is just about $7 trillion in total, and it's probably just about 9% to 10% maximum of global assets under management. So we’re talking about something that's smaller than the mutual fund in the whole today, it’s still a lot smaller, mutual fund industry is easily 5 or 6 times bigger. And hedge funds are smaller but hedge funds can leverage easily 3 to 5 times and their impact could be as large as ETFs, if not bigger. [42:00] The active trading, you’ve got to look at the underlying use, the hedge fund index, whether it's through a mutual fund or selling the underlying, they're going to do it anyway. Whether they can use ETFs today to do so or not. They are going to short because they're active trading by nature. I just want to throw a question for Anthony as well. Is it true that, in general, I know there's a lot of ETFs types, but in general is there more passive in nature or just does not attract as much active investors into it than otherwise?
Anthony: Do you mean to say that people tend to hold ETFs for longer periods of time?
Freddy: Yeah. As a community of ETF users, can you say that the majority still towards attracting a more buy and hold behaviour than trading?
Anthony: Yeah, absolutely. I think that is the case. Most evidently that's more likely to be the case for retail investors who are looking to build a retirement solution or do something with their savings. But when we look at institutional investors, we did a survey last year and we do it most years actually, where we survey Asian institutional investors. But now 65% of them are saying that they use ETFs for core allocations in their portfolio to build a position that they maintain for a longer period of time.
Freddy: Right. I would say that there was some criticism about March on ETF, but my response would be, it's simply because ETFs are more transparent with how it shares information that we see the NAV [44:00] of an ETF, for example, TLT, 20 year plus US government bonds. In the peak of liquidity pressure in March, it was trading at maybe around 6.5% point below the value of the underlying assets. But that's simply because people are getting margin calls and they are selling something that's profitable and working to cash out to pay margin calls elsewhere, ETF has come through with providing liquidity but doing so at a discount of the fund’s value versus its assets. But I would counter that and say, the same would have happened if the mutual fund/unit trust would have been more transparent in real-time pricing that they have that discount as well. They just don't do it, because we report that that’s why people are seeing the ETF being discounted, and hence ETFs are the bad boys. I mean, it's a chicken and egg problem.
Philipp: Yeah, I think you also have to always in any kind of discussion look at where the arguments are coming from. What's the interest of the person doing the arguments? I think it's always quite important as well. I think Anthony, you can correct me if I'm wrong, but I think by having easier access to investing, people can start investing into ETFs with low amounts of initial investment. They're cheap, they’re traded on a stock exchange, so they're very easy to buy into. I think that gives a lot of liquidity to the market, in general, you get access to. More and more people around the world, through the internet and technology and ease of use of ETFs are actually now market participants, whereas before maybe it would be too much of a hassle to get started in investing, I don't have enough money. So all these things contribute in a positive way. [46:00]
Anthony: Yeah, and because of that ETFs flexibility, the lower minimums and lower cost, it's very easy for a retail investor to build a portfolio of ETFs with a small amount of money and have something that they can then add to on a monthly basis, so that they can, dollar cost average. When markets are going down, they bring down their average cost of their investments if they keep investing in that period. If you're investing for a medium to long term goal, to a certain extent you're less bothered about daily volatility or pricing dislocations that may occur which we have seen tend to even themselves out over a couple of days trading.
Philipp: Yeah, I think this is where I wanted to shift to next. The discussion is more on the listeners and seeing how they can get exposure to ETFs now that they learn more about them, done their research, and then a lot of things that they need to consider before selecting an ETF. So I think we already talked about access, I think we said hey, you can go to your local broker, you can go online opening up accounts, it's quite easy to get access to ETFs. You can get access to an ETF strategy if you go with StashAway and what Freddy does. All of these things are available to everyone now. StashAway we do it, you can start with $1 if you really want to. I think it's about $10 to $50, we can build your portfolio because we use fractional shares.
I think getting access to the product is easier than ever now. But if people go about and say, okay, I like that idea, it's easy to get access to, I want to invest my money, I want to move something [48:00] out of other portfolios where I've been paying a high fee, and I don't agree with it anymore. What are some of the key considerations that they should take into account for selecting an ETF? Because we touched it early on, that not all of them are equal when we talk about tracking error, but are there other points that they should take into account and compare ETFs even if they seem on the surface, they seem the same, but underneath they're not like Freddy mentioned earlier. What are some of the things that they should look for before saying, hey, I'm going through with this one?
Anthony: Sure. First of all, the most important thing to look at is exposure. If you want to get into US equities, you've got to make sure that the ETF you're buying gives you US equities and the slice of the market that you want. Secondly, structure. We talked about the impact of synthetic, which is a derivative-based ETF structure versus physical. In that situation where you're buying synthetic, you're just introducing another level of risk because you're dependent on the counterparties for derivatives. So it’s additional risk and potentially additional cost. They may be small, but they are there. Thirdly, I'd say you want to look at the domicile of an ETF and the impacts on your tax situation. We typically say to investors that in Hong Kong and Singapore that are taxable, that they should use UCITS ETFs. But having said that, I know some providers have a way of buying US-listed ETFs and giving back any tax on withholding.
Philipp: Yeah, that's a good topic because currently, we use [50:00] US-traded ETFs. And that question comes up quite a lot for Freddy all the time, of why is he still going with a fund that has the forced withholding tax on some form of dividends and interest versus going with a UCIT that has maybe a little less. Maybe, Freddy, you want to want to chime in there really quickly because that is one of the key considerations. A lot of people misunderstand that as well, right?
Freddy: I think the confusion came from the fact that either you count the beans on the table or you don't, or you look at the beans outside the table as well. The way we approach it is to look at all costs that are in there. The expense ratio can be higher in UCITS than the US one, let's say they track the same thing. But sometimes not true, but the tracking error could be wider or could be... We try to look at that and also at the same time they are optimisation strategies that we built for the US-listed ones where we minimize dividend tax impact. For example, on the bond side that we selected, the ones that all qualify under the QII, qualify interest rule for a majority of it to be reclaimed in the financial year and minimise it. And on the equity side, yes, you do get those dividend taxes so you try to focus your strategy more on reinvestment rather than on ETFs that track stuff that pays out more dividends. So there's some strategy that we can build in to minimise the impact. And hey, it's not zero, it’s 15 to 20% on two say, and you talking about 30% on two in the US. And the difference of 10% on two is 0.2. And is that easily [52:00] overwhelmed by wider bid-offer, tracking error or higher expense ratios? You got to count all the beans that are on the table and not on the table.
Anthony: Yeah, Freddy is absolutely right. We spent a lot of time with our clients on this where we'll say to them, you need to look at more than just the expense ratio of an ETF and there are different components to what holding an ETF is going to cost the investor. Some of that is the expense ratio, again, tax is going to have an impact. And then also, the bid-ask spreads, how liquid is that ETF and how tightly does it trade? And if you're paying a large spread, the difference between the price as you go in plus any commission. That can add up to the total cost of what it is for an investor to hold an ETF. I'd also say just that on selection terms there are two other points you should look at. One is performance, just how closely does an ETF track the benchmark that it's meant to be following which we covered earlier. Then this liquidity point which really just plays into the issue of bid-ask spreads and how tightly ETFs trade, that's very important to look out because it can be quite wide on some funds.
Philipp: Yeah. I think that's why I wanted to ask Freddy another question on...I know we just talked about for a little bit but for example, for the listeners who are in Singapore, you can theoretically buy I think there is now one or two, I can't remember exact number you might know, of S&P 500 ETFs traded on the Singapore Stock Exchange. Why would you say it's still a better choice to go with a US-traded one versus that one? Is it based on liquidity? Is it based on [54:00] the overall cost?
Freddy: It's both actually. A better example could be GLD, Gold, that's denominated in Sing dollars and then versus the US one, that liquidity is vastly different in the two. And the US version is the bread. So that's just an example. You've got to look at that. We also, in addition to what Anthony has said, we have to look at the tracking error in the up scenario and in the down scenario. For example, is the tracking error better when things are up or is the tracking error worsening when things are down? If it’s worsening when things are down it also says something about the liquidity and the time zone.
Philipp: No, I think that makes lots of sense. But that's a question that people will have, hey, why should I not just buy it here when I can get it from home instead of going abroad for that? Thanks. I think those are really good five, six points that we covered there that people can take away today, and actually start looking out for when they do make the decision to get into ETFs. I think we covered quite a bit here in terms of history, we demystified some of the ETF bubble questions and we help people understand where they can buy the ETFs and what they should consider when selecting an ETF. Maybe to bring it to a closed-loop especially since we have Anthony here with us today. What does the future have in store for ETF investing? What do you see out there in terms of the industry going forward? What are parts of the industry that are still being able to be unlocked that have not been touched by ETFs? What do you see there? [56:00]
Anthony: Expansion. The ETF growth we think is going to kick on from where we are, and we project almost a doubling in assets by the end of 2023 to $12 trillion from the around $6 trillion that we have in the market today. But I think the coming trend, and I talked about this a little bit earlier, is really in sustainable investing. We've seen that this year, particularly, we've seen sustainable investing ETFs gather $15 billion which is coming from quite a low base, but really accelerating in terms of their use, and that's really just, I think it's sort of its awareness of some of the issues that, like climate change affecting the planet, but it's also things like good governance of companies and that's increasingly coming to the fore in ETF format, because retail investors have an increasing awareness of this and want to do good with their investments as well. But they don't want to sacrifice returns in doing so. I think sustainable investing is now proving that you can both do good and generate good returns.
Philipp: Yeah. You mentioned sustainable investing, which then feeds into one of the trends that are happening also with people having an opinion about something they want to invest in, they want to not just invest to make, yes, they all want to make profit. But they also want to have a say or want to feel good about their investment. With that comes thematics, right? I think that is a topic that is gaining a lot of steam in the US and in Europe, you can see a lot of digital or like FinTech [58:00] companies that really are going after that market by offering thematic portfolios to investors because maybe an investor likes to go into biotech. So we can make a theme around biotech and then pick the companies around that and put them in an ETF. How do you see that thematic ETF development? Is that where a lot of the growth will be coming from not just the sustainable piece, but also different other themes?
Anthony: Yeah. We're certainly seeing a lot of growth in thematics and I touched on this point a little bit earlier that the greater ability that we have now to manipulate big data means that we can really drill down into supply chains and get much more granular in terms of the sector exposures or themes, if you like that people want to invest in. For example, you can buy an ETF that looks at electric vehicles, and it will look at the supply chains for electric vehicles, or you can look at something like digital security. I think what these themes do is really access emerging trends that are driven by what are called megatrends. And that's how long people are living, people are living longer. It's an economic shift from western worlds to the east, and rapid urbanization. We're seeing that particularly in developing countries. Then lastly, which is perhaps the most obvious is increasing digitization and automation coming through in the economy.
Philipp: Freddy, is that something you're also tracking? What is your thought about thematics in terms of portfolio construction? Is it something you're thinking about? Is this something interesting to you as well?
Freddy: Absolutely. I've been monitoring the progress ETF as a whole [1:00:00] is making in the space, is up and coming and not to a stage where we would do it in a big way. But I think in a couple of years is going to really take off and there'll be more options and alternatives in the space for sustainable investing, thematic investing, and even ESG environmental social governance, that thing. Just as an example, governance could actually be an important factor even for an investor. Just think about Toshiba, Westinghouse as an example. Westinghouse has this long-term liability with decommissioning nuclear plants and regulations have stepped up. So there's a potential legal liability and that would be reflected in the stock price of the owner, Toshiba. The stock price, right? And they did mismanage that a couple of times, got warnings in Europe all over and that became a problem for the stocks. So, as a factor this really works to also flat risk for investors. So, thematics, the ESG, the sustainable investing, if they are not too overvalued or already at a point in time, they could actually serve as risk diversifier for a multi-asset portfolio.
Philipp: Exactly. Just using the wave of trends to maybe for a few years, just portfolios, I think there's some super interesting developments ahead over the next decade that we'll be witnessing. Thanks for giving an overview there because I know especially for people, 50 and below actually I see this come up a lot during webinars and seminars. People asking, hey, can we offer more thematic portfolios? Because it's on people's mind, like Anthony said before. [1:02:00] People think more sustainable nowadays. Then it's really creating an industry within the ETFs space of how to allocate that capital to those areas. So, thank you both for that. Before we close up. I wanted to just hear a little bit of your parting words from both of you maybe in terms of the next, let's call it the next decade.
We've seen this in the US over the last decade that I was, most of the decade I was in the US. And after the financial crisis, people lost - there are no more or not many more defined benefit schemes around the world where people just put money in. The company allocated the capital, here is what you get out at the end. Here is your 2, 3, 4, $5,000 retirement paycheck. That's not the norm anymore, especially where I come from as well, in Germany, a lot of people are still relying on this, but companies like anyone getting out of college nowadays will not have access to these pension plans anymore. So, the onus is on the individual and I think this is where ETFs can play a pivotal role in helping people manoeuvre this. Is there anything that you want to say to the audience, like as parting words of how they should be investing or how you look into doing it for yourself in terms of securing your future?
Anthony: Yeah, as you said it. The end of a lot of these defined benefit schemes really does push the onus on to investors or general workers now to come up with a retirement solution themselves. Where ETFs really help with that is really the low cost. If you think your retirement portfolio [1:04:00] is going to be in existence for a couple of decades or longer hopefully, what you should see is that it grows as much as it can, but the key component for that to happen is minimising the cost that you have in the portfolio because costs once they get compounded year on year on year, really can significantly diminish returns over the longer term.
Philipp: Yeah. You managed to squeak in there the fees and the compounding of fees and I think that's the one thing an investor can control. You can't control the market in the short term, but you can control your fees and it's an important aspect of managing at least the part that you can control. Freddy, anything from you there?
Freddy: Well, before I quote my favourite sentence of all time. I'm going to say that, thanks to the ETF revolution, it has given us no excuses not to start early. My advice is to start early, regardless of age and wealth level. All those barriers are gone now because the minimum has to come down, the fees have come down, liquidity has gone up, the flexibility has gone up, and the amount of choices has also gone up. So, there are no excuses not to start early anymore. Here's this, the power of compounding is the eighth wonder of the world. So said by Albert Einstein, my favourite physicist, and person of all time. He's a physicist and he's talking about the expanding universe. But the same concept applies to investing too, the power of compounding.
Philipp: Exactly. Thank you so much both of you. This was super insightful, [1:06:00] today's episode. Thank you both very, very much for being here and taking the time out of your day to do this for our audience. I'm sure we might have both of you on again, because there's quite a bunch of topics that we could still cover when it comes to ETFs as well, but that's for the future. With that being said, I hope everyone enjoyed today. Again, give us your feedback. What do you want to hear more about? What do you want to hear about in the future? And we will be back with you again shortly. Thank you so much.
Anthony: Thank you for having me.
In this episode of In Your Best Interest, Anthony Arthur, Head of iShares Asia ex-Japan Wealth Distribution, BlackRock and Freddy Lim, Chief Investment Officer and Co-founder of StashAway talk about exchange-traded funds (ETFs). They cover the history of ETFs, the similarities and differences between ETFs and mutual funds, and what criteria you should consider before investing in an ETF. Anthony and Freddy also share their thoughts on the potential future growth of ETFs and the emergence of thematic ETFs. If you enjoy what you've heard, we’d really appreciate it if you’d even consider leaving a quick but thoughtful review. It takes less than 60 seconds, and it really helps us make the show even better for you so that we can convince great guests to join us.
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Also, our lawyers would want us to tell you that the opinions of our guests are not necessarily shared by StashAway, that past performance is no guarantee of future results and that what you heard is not investment advice.
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