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Welcome to Firstlinks Edition 557 with weekend update

  •   25 April 2024
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The Weekend Edition includes a market update plus Morningstar adds links to two additional articles.

This week, First Sentier made headlines with its decision to hand $14 billion back to investors. The firm, with $238 billion under management and owned by Japan’s Mitsubishi UFJ Trust since 2019, announced that it would close its Australian fixed income, global credit, emerging companies, and equity income units.

The firm’s global head of investment management, David Allen, was refreshingly honest in his explanation of the announcement. He told various media outlets that the units couldn’t “attract enough assets at the right fees”. For instance, he said the $700 million Australian microcaps team had performed well yet was too small to generate enough profit. On the equity income strategy, Allen suggested that: “More of the world has realised that you don’t need to live off income in retirement. You can maximise your total return and take capital out of your investments.”

The company’s decision to shut down the fixed income and credit teams came as more of a surprise. Allen said that fixed income could only charge minimal fees but required larger teams to manage the assets. Thus, the fees coming in didn’t justify the expanded cost base: “It’s hard to get the numbers to stack up. It’s a scale business…”

Allen suggested that First Sentier would instead focus on its Australian growth and small cap equities funds, as well as expand its private market offerings. Intriguingly, he pointed out that private markets don’t come with the same competition from ETFs and managers could charge higher fees, making this area especially attractive.

First Sentier’s announcement is the latest sign of fund managers continuing to grapple with the ETF boom and, more recently, the increasing internalisation of investment management at super funds.

ETFs may be sowing seeds for future downturn

Ironically, the news comes as the ETF boom is showing signs of froth, with more dubious products being pushed to investors.

For instance, The Bank of Montreal launched a 4x leveraged stock exchange traded note (ETN) late last year. The MAX S&P 500 4x Leveraged Exchanged Note (NYSE: XXXX) allows massively leveraged bets on the S&P 500. The product’s launch raised eyebrows as proposals for 4x leveraged index products were rejected by the SEC only a few years earlier. That hasn’t stopped investors from piling in, with the ETN up 33% in about five months.

Though not as geared, there have been plenty of leveraged ETFs launched into the Australian market over the past year too.

Also noteworthy is the approval of Bitcoin ETFs this year. Blackrock’s iShares Bitcoin Trust, launched in January, has amassed more than US$17 billion in assets. Such ETFs have helped fuel demand for Bitcoin, whose price has propelled 51% higher this year.

Additionally, there have been a plethora of thematic ETFs launched over the past few years, some designed more for speculators than investors – including video game, Metaverse, ‘future of food’ ETFs.

Finally, there are more ETFs coming out where the underlying assets have nothing to do with the theme or name of the ETF. It’s likely that investors often don’t know the constituents of the funds that they’re buying. I’ll expand on this topic in a future article.

All this seems fine while markets are going up – the providers of these products and the people buying them look like geniuses. Yet this ‘easy money’ could well be sowing the seeds of a future downturn for the ETF industry. That’s not to say that the structural growth trend for ETFs is over, but that a clean-out of marginal providers and products may be overdue.

Opportunities and challenges for investors

Newer ETFs are focusing on the most popular areas of the market, including growth, ‘quality’, and momentum stocks. Think large cap, tech, energy transition, electric vehicles, cybersecurity, and cryptocurrency. These are the areas where more marginal products are appearing and deserve caution.

Conversely, there are other areas of the markets that are being ignored because they don’t provide the necessary popularity and/or liquidity that ETFs require. Value stocks are being left for dead because they don’t have the popularity, momentum, and often liquidity to make it into ETFs. The same goes for small caps and microcaps.

The silver lining for ETF providers and fund managers

The current struggles of fund managers are likely to lead to an industry that delivers better product and better performance to its customers. And if ETFs do cool off, fund managers will be better prepared to take advantage of it.

For the ETF industry, any shakeout of marginal players and products should strengthen the hand of existing, larger providers, and sharpen their focus on the end customer.

*Full disclosure: First Sentier is a Firstlinks’ sponsor

James Gruber

In this week's edition...

How useful are the retirement savings and spending targets put out by various groups such as the Association of Super Funds of Australia, otherwise known as ASFA? Not very, according to Kaye Fallick, and it's reducing the ability of ordinary retirees to fully understand their retirement income options.

Rudi Filapek-Vandyck investigates why the US stock market has significantly outperformed Australia's over the past 15 years. His answer? It's because they have some incredible businesses. Not that we don't have great companies here, but Rudi says that you have to know where to look.

Bank hybrids have become popular places to park money, though it's led to these securities being priced at a premium. Does that mean investors should stay away, or sell? Norman Denham says that as long as banks don't pay up for term deposit funding - which looks likely for a while yet - investors will continue to pay a premium for the higher yielding, but riskier hybrids.

There's been a lot of debate about the Magnificent Seven and whether it's resulted in too much concentration in US indexes. Whatever your view, nabtrade's Gemma Dale says the rise of the tech behemoths poses several challenges for global investors.

The price of copper is soaring due to surging demand from data centres and renewable energy. Supply shortages could last for some time, leading to higher prices for longer, says Man GLG's, Albert Chu. That, in turn, has implications for the growth of AI and the transition to cleaner energy.

Global REITs have been out of favour for some time. Yet, Resolution Capital's Marco Colantonio says that while the office market remains a concern, the remainder of the sector is in good shape and offers compelling value, with many REITs trading below underlying replacement costs.

Daniel Crosby says that money is fantastic, to a point. However, if we relentlessly chase wealth at the expense of other facets of well-being, history and science both teach us that it will lead to a hollowing out of life.

Two extra articles from Morningstar for the weekend. Seth Goldstein looks at why Tesla's earnings plunged yet its shares surged, while Mathew Hodge examines Brambles' poor trading update

Finally, in this week's whitepaper, VanEck presents its outlook for Australian equities.

***

Weekend market update

On Friday in the US, stocks ripped higher by 1% on the S&P 500 and 1.5% on the Nasdaq 100, as the bulls managed to answer last week’s rout with a 2.1% and 3.5% respective rebound for those major indices. Long-dated Treasurys enjoyed a bounce as 30-year yields settled at 4.78%, down four basis points on the day and six basis points above last Friday’s finish, while WTI crude stayed near US$84 a barrel and gold edged higher at US$2,339 per ounce. The VIX retreated to 15, more than three points south of Monday’s early levels. 

From AAP Netdesk:

The local share market on Friday finished the week on a sour note as persistent inflation had investors worried the Reserve Bank's next interest rate move could be up rather than down. The benchmark S&P/ASX200 index on Thursday fell 107.1 points, or 1.39%, to 7,575.9, to finish the week up 0.11%. The broader All Ordinaries closed down 100.1 points, or 1.26%, at 7,837.4.

Every official ASX sector finished in the red, with real estate stocks the worst hit, down 1.9%.

The index was dragged down by its largest company, BHP, which sank 4.6% to $43.15 after the iron ore heavyweight confirmed it had made a $60 billion bid for British copper miner Anglo American. The merger would have made BHP the world's biggest producer of copper, with about 10% of existing supply. However, late in trading, Anglo American said it would reject the offer.

Fellow iron miners Rio Tinto and Fortescue climbed 1.1% and 3.4%, respectively, as the ore's price firmed to a two-week high.

Shares in goldminer Newmont were up 13.9% to $65.70 after it reported an increase in first-quarter revenue, driven in part by record gold prices. The company announced it had offloaded a $330 million credit facility in Lundin Gold as it looks to monetise non-core assets to help finance its $26 billion acquisition of fellow goldminer Newcrest.

The big four banks all fell, with CBA down 1.8%, NAB slipping 1.4%, and Westpac and ANZ 1.9% lower.

Furniture retailer Nick Scali surged 12.7% after completing a $46 million institutional placement to raise funds for its UK growth plans.

Sleep apnoea device producer ResMed climbed 9.6% after announcing a 25 per cent boost to first-quarter profits, driven by increased demand for its products and cost improvements.

Super Retail Group dropped 3.4% after revealing two employees were preparing to launch legal action against the company over claims CEO Anthony Heraghty had an undisclosed relationship with his former HR chief.

From Shane Oliver, AMP:

  • The good news is that annual Australian inflation is continuing to fall being down from a high in December quarter 2022 of 7.8%yoy to 3.6%yoy in the March quarter and it’s in line with the range of other major countries, albeit at the top end.
  • The bad news is that it came in higher than expected and so means that rate cuts will be delayed with a high risk of another rate hike. While annual headline inflation at 3.6%yoy and underlying inflation at 4%yoy slowed in the March quarter both came in stronger than our own, market and RBA forecasts due to strength in services prices - for rents, health, education and insurance in particular. Goods price inflation continues to see softness running at a quarterly annualised pace of 2.1%, but the strength in services inflation at a 5.7% annualised pace pushed up the breadth of CPI items seeing annualised inflation above 3%. While headline CPI inflation still looks on track to fall to the RBA’s forecast for 3.2%yoy by December, underlying inflation looks like coming in above the RBA’s forecast for 3.1%yoy by December and so may be revised up by the RBA in its updated forecasts to be published after its May meeting. Interestingly this will likely just take the RBA’s trimmed mean inflation forecast back to where it was last November. 
  • The combination of sticky services inflation will leave the RBA cautious and still waiting for greater confidence that inflation will return to target in a reasonable time frame and its likely to signal this at its May meeting. The RBA will likely also debate whether another rate hike is needed. We don’t think it will be or that the RBA will hike again but it is likely to reinstate its tightening bias and another rate hike is now a high risk. The money market has moved to price in about a 50% probability of a hike in December and sees no cut in the next year.
  • While the RBA has raised rates by less than other major central banks which have converged on 5 to 5.5%, Australian mortgage holders have been world beaters when it comes to the rise in their mortgage rates thanks to their high exposure to variable rates or short dated fixed rates. The average mortgage rate on outstanding mortgages in the US is up just 0.5 percentage points since the start of rate hikes whereas in Australia the rise has been around 3.2 percentage points. While the Australian households have so far been resilient on average despite this, this resilience would be severely tested with more rate hikes particularly as the protective factors (like saving buffers, a strong jobs market and a high proportion of fixed rate loans) of the last two years run down. Which is why we would be cautious of more RBA rate hikes. 
  • Pre-Budget silly season. The last few weeks have seen the Treasurer commenting that the global outlook is “fragile and fraught” and that the revenue outlook has deteriorated. This looks more like an attempt to dampen expectations ahead of the Budget though as the reality is that the IMF has actually revised up its global growth forecasts and the iron ore price has continued to run ahead of Treasury forecasts making likely another solid budget surplus this financial year. And with inflation proving sticky the upcoming Budget should be focussed on taking slightly more out of the economy than it puts in so as to bear down on inflation and make the RBA’s job easier. There is room for cost-of-living relief and in particular a continuation of energy bill relief makes sense otherwise eligible households will face a rise in electricity bills even though retail prices are falling. And measures are likely to be announced to formally get the “Future Made in Australia” protectionism underway. But any new spending needs to be more than offset by savings elsewhere.

Curated by James Gruber and Leisa Bell

Latest updates

PDF version of Firstlinks Newsletter

Australian ETF Review from Bell Potter

Quarterly ETFInvestor (ETF Market Data) from Morningstar

ASX Listed Bond and Hybrid rate sheet from NAB/nabtrade

Listed Investment Company (LIC) Indicative NTA Report from Bell Potter

LIC Monthly Report from Morningstar

Plus updates and announcements on the Sponsor Noticeboard on our website

 

7 Comments
Trevor Astley
April 29, 2024

Has anyone considered that we are close to peak growth?
There's all this money sitting around waiting to pile into the next trend.
I think the Aussie market is going nowhere, the only thing propping it up is everyone's super money, looking for a home each week.
Any decent company that looks promising is swooped upon by the private equity vultures.
Anglo American "Copper Miner " ..... they are a well diversified miner, Diamonds Platinum Metallurgical Coal iron ore fertilizer minerals etc ...hmmm

David
April 26, 2024

Nothing wrong with XXXX. 4x leveraged can be supported depending on the volatility of the underlying. Probably less risky than 3x leveraged on the NASDAQ due to less volatility.

Laura
April 25, 2024

>90% of the FUM/flows in the ETF space goes to broad-based/low cost/vanilla equities or bond strategies; a rational response to the persistently poor outcomes achieved by the bulk of expensive active strategies. That said, 90% of the attention is directed at niche/thematic ETF products. This article, sadly, is another tired example of that 90%.

Jake
April 25, 2024

Laura,

Bitcoin spot ETFs received US$12 billion in net inflows in the first quarter of this year, out of the total US$195 billion in net inflows for all US ETFs. And those Bitcoin ETFs only went live on January 11 - so the inflows were for 2.5 months!

And the iShares Bitcoin Trust ETF got US$14 billion in inflows, the second largest inflows of any ETF in the US in Q1. It was ahead of the iShares Core S&P 500 ETF and almost every other plain vanilla ETF.

And that's not to mention that tech-specific ETFs which received $11 billion in inflows in 1Q in the US.

It's far from trivial issue...

Steve
April 25, 2024

It's twofold. Why would I bother with 5%pa (or less) on Govt bonds that become worthless against inflation, when I can get between 7% pa to 11% pa on other fixed interest investments.
Secondly, the fees on a lot of fixed-interest managed funds are too high, compared to ETFs.
It's that simple. This is why many advisers prefer having access to an "All Growth" multi-blend fund (with NO bonds in it) to outsource to, and we can easily get up to 11% on the fixed interest component ourselves. For the past 30 years, the bond component has always been a drag on long-term returns.

Stephen
April 25, 2024

True fixed interest is about the return on your money. If you are expecting a 7% to 11% yield you are not investing in that type of fixed interest. You are investing in a product where you should be concerned about the return of your money.

That may appear to be a subtle difference, but when things go wrong it means a lot. In those circumstances you will likely find that the risk in your “fixed interest “ portfolio and your equity portfolio are highly correlated.

Maurie
April 25, 2024

The progression of the ETF industry reminds me of the tech industry around the turn of the century. Enthusiastic “investors” with an insatiable desire to jump into any new product (Dotcom company) that has ETF in its name. Funny how this behaviour is associated with rising markets. How did the tech boom end? A washout of all the fringe players leaving the more solid participants to rise from the ashes and go on to become industry heavyweights. Back then, the future profitability of the tech sector was considered a no-brainer; the metric was “eyeballs”. Today, the ETF phenomenon is the no-brainer, the metric maybe “FUM”

 

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