Exchange-traded funds (or ETFs) are a type of managed fund that is traded on the Australian Stock Exchange or Chi-X. Comprised of a diversified portfolio of investments, usually shares or bonds, ETFs can be a simple and easy way to invest.
There are two types of ETFs: passive and active.
While passive ETFs mimic a particular share index (eg the S&P ASX200), Active ETFs do not. As the name suggests, these funds have a dedicated fund manager making active investment decisions about the portfolio’s allocation to individual shares or bonds. Each fund has an investment objective, and the fund manager’s aim is to outperform that objective
First, let’s look at the similarities. Active ETFs and managed funds are both actively managed by a fund manager. Investors buy units and the fund managers invest those units on the investor’s behalf within a regulated trust structure. Both offer diversification and market exposure.
Where they differ is that Active ETFs are traded on the stock exchange, while managed funds aren’t. This means investors can benefit from live prices throughout the day and can buy and sell units in an Active ETF just like buying a share, without having to complete application or withdrawal forms each time. Active ETFs are generally able to provide liquidity during market hours. Active ETFs also provide administrative ease and flexibility for many investors, as they can be monitored and reported on alongside the rest of the investor’s portfolio held via their brokerage account.
With a single purchase of an Active ETF you can access a portfolio of securities you may not otherwise be able to purchase individually. In addition, the transaction costs of an Active ETF can be lower than if you traded the individual securities (eg shares or bonds) yourself or through a broker. What’s more, Active ETFs allow you to invest in asset classes or markets that individual investors can’t easily access themselves, such as fixed income or global equities. You also benefit from the expertise of professional investment managers.
Listed Investment Companies (LICs) aren’t required to provide detailed information about their portfolios, and they only need to disclose NTA each month. This generally makes them less transparent than Active ETFs that provide daily portfolio disclosure and/or an iNAV throughout the trading day. Because LICs are closed-ended, they don’t have the same capacity to create or redeem shares to meet investor demand, meaning they can trade at prices that are above or below NAV, or fair value.
Active ETFs provide you with the ability to diversify your portfolio through holding a single security and to create a diversified portfolio of ETFs across asset classes.
As a traded security, an Active ETF enables you to enter and exit your investment on the ASX generally any time during trading hours. This flexibility also provides an efficient way to implement asset allocation changes to your portfolio.
Active ETFs provide daily portfolio disclosure and/or an iNAV throughout the trading day
Active ETFs operate in a similar way to ordinary shares or Listed Investment Companies (LICs) on the stock exchange, in that they have both a primary market, where shares or units are created or redeemed, and a secondary market, where shares or units are traded after being created.
However, unlike shares and LICs, ETFs are open-ended, which means the primary market remains open during market hours. So unlike shares or LICs, which have a limited available supply of shares, units of ETFs continue to be created or redeemed to meet investor demand. This mechanism balances demand and supply, acting to keep the current market price of units throughout the trading day very close to the net asset value (NAV) — the ‘fair value’ of the underlying assets inside the active ETF.
Like shares, ETFs are traded using an ASX code. Orders can be placed with your broker using a market or limit order. Market prices are live throughout the trading day.
In the primary market, only Market Makers and/or Authorised Participants create and redeem units with the Issuer of the active ETF. The difference between Market Makers and Authorised Participants is that Market Makers have a special licence from the stock exchange operator and as such must quote buy and sell (bid and offer) prices throughout the trading day. Authorised Participants are not obligated to do this.
In some cases, the Fund Manager may not wish to disclose the composition of the underlying portfolio every day. In this situation, the Issuer may perform the market function itself or appoint an agent to do so and will publish an indicative NAV (iNAV) though-out the trading day. This allows buyers and
sellers to check the indicative ‘fair value’ when they go to trade units.
In other cases where the Fund Manager is comfortable with providing full portfolio disclosure, the Market Maker and/or Authorised Participant is separate from the active ETF, creating and redeeming units with the Issuer of the ETF. These units are then traded with investors on the secondary
market. In this case, the Issuer of the active ETF must disclose the full portfolio composition every morning to the market, giving both Market Makers, Authorised Participants and regular Investors access to the same information to inform the trading price of the active ETF units. Active ETFs that operate like this are very similar to traditional passively managed ETFs that track indices.
Fixed income funds invest in bonds and other debt instruments issued by governments, banks, corporations and assets like property or infrastructure.
For an investor seeking an allocation to a defensive asset class, fixed income has traditionally been a core asset class of choice. Fixed income investors must be repaid their capital at some specific point in time, unlike equity, which adds considerable security to investors’ wealth.
In addition, fixed income can provide a stable stream of income as debt issuers are contractually obliged to make regular interest payments. This compares to equity dividends, which can be cut at any time. This generally makes fixed income less volatile than equity investments and is often incorporated in the defensive component of an investor’s portfolio.
Investors usually choose fixed income funds because they can provide a regular income stream and are great at diversifying a portfolio of different investments. They’re a stable investment that can provide certainty in both up and down markets.
When used in a portfolio with equities, fixed income investments can smooth out your returns when share markets are falling and provide you with a steady source of income.
When used in a portfolio with cash, fixed income investments can increase the returns you receive from the portfolio – especially if cash rates are low.
Fixed income fund managers can either be:
With global income rates at an all-time low, a passive fixed income fund may not provide you with your desired amount of income or the low risk outcomes that fixed income is expected to deliver. An active fund manager can potentially improve your returns and lower risk by expertly managing the fund’s exposure to different types of fixed income investments.
Fixed income investing is complex and includes a lot of variables. You should look for a manager with a tried and tested investment process that has helped them achieve strong performance through all types of market conditions. The manager should be able to demonstrate that they can add value above and beyond inflation, or the returns you would receive from a passive fixed income fund or investing in cash (depending on the objectives of the fund).