Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 268

ETFs: survival of the fittest

The growth of Exchange Traded Funds (ETFs) has been one of the greatest global investment success stories of the past decade. In Australia, the increase in appetite for ETFs is reflected in the surge of listings with 179 ETFs available in 2018, up from 30 in 2010. However, little attention has been paid to the risks in some ETFs for investors.

While ETFs provide easy access to market segments and low-cost asset allocation tools showcasing a wide range of strategies, Zenith believes investors need to pay attention to potential red flags on the longevity of individual ETFs before investing.

Growth and diversification

Industry competition has developed rapidly. The following charts show how the market has expanded since 2011, with a material increase in the number of ETFs and range of market segments (depicted according to size).

June 2011

Click to enlarge

June 2018

Click to enlarge

Expanded availability of options is broadly a positive. However, this shouldn’t mask the risks associated with some ETFs that struggle to gain acceptance and achieve scale.

Investors are becoming increasingly sensitive to costs. Trends both locally and globally show that ETFs which act as low cost, core building blocks gain the greatest traction. The following chart shows all ETFs on the ASX measured by size and annual management fees (ex ‘Active’ products). Data points are unlabelled as this is less about ‘who’s winning’ than the broader themes.

Click to enlarge

There is clearly a relationship between fees and Assets Under Management (AUM). Over time, as ETFs reduce fees, they typically accelerate AUM. Leaders across the asset classes are generally first quartile for cost competitiveness, although there are some newer, cheaper ETFs which have not had time to build scale.

Achieving scale

Common denominators in ETFs which achieve material scale are:

  • Competitive fees relative to peers
  • Core market exposures
  • Relative attractiveness of a strategy within a peer group
  • First mover advantage
  • Issuer business model, including scale, product diversity and marketing effectiveness.

While strong performance can drive short term growth, it typically lacks persistence as a factor.

As AUM rises, management can potentially reduce expense ratios as efficiencies increase. This can promote a positive feedback loop, where an ETF gains AUM, increases efficiency, lowers costs and gains yet more AUM. Cost competitiveness between products means investors reap the rewards as expense ratios fall.

While core ETFs have benefitted, the same cannot always be said for some niche products. ETF’s key attraction is the ability to bring asset allocation tools within reach of the average investor.

But specialisation can have drawbacks. The pool of investors to which specialised ETFs appeal may be shallower, and while fees tend to be higher, lack of scale can limit issuer profits. While their investment premise can be valid, a specialised ETF has a higher business-viability threshold.

The following chart shows growth in market capitalisation for individual ETFs, measured in six-monthly intervals for the first seven years from listing.

Click to enlarge

There is a recognisable separation between ‘leaders’ and ‘laggards’. Occupying the middle ground are the ‘moderates’, those ETFs although successful, have failed to attain the momentum of the leaders.

Leaders are typically distinguished by cost effectiveness and core exposures. Obviously, cost is not the only thing that matters, however, it is clearly a dominant factor in investor preference.

The laggards face the risk that they fail to benefit from increased efficiencies enabled by growth, which in turn can result in stagnation and in some cases, delisting. We believe that there is a danger zone for ETFs failing to exceed $100 million in their first three to five years of operation.

Negative attributes inhibiting ETFs from achieving scale reflect success factors:

  • Uncompetitive fees relative to peers
  • Highly specialised exposures
  • Complex investment thesis
  • Issuer businesses lacking scale, product diversity and marketing effectiveness.

Since 2010, 17 ETFs have been delisted, mainly due to increased competition and poor performance which have contributed to lack of investor take-up. While only equating to approximately 1% per annum (by number), Zenith believes the rate of terminations will increase. By comparison, in the more mature market of the US, ETF delistings have averaged approximately 7% per annum over the last decade.

Consequences of a delisting

Small scale and poor market performance over a multi-year period can be leading indicators for delisting. Closure of a product has two main primary effects on advisers and their clients.

First, there is a potential sequencing issue. Delistings sometimes occur after prolonged negative performance. Over two-thirds of all delisted ETFs delivered negative total returns over one, two and three years prior to their delisting date. The following chart shows the median and average per annum net return across these ETFs prior to delisting.

On delisting, investors are generally forced to exit and therefore crystallise a tax event. Naturally, there is the risk that for some, the timing can be far from ideal. The delisting of an ETF removes investor choice as to whether or not to maintain market exposure.

Second, the process of changing an exposure can be time-consuming for both advisers and clients. Depending on the arrangement, there may need to be discussions and a Record of Advice or new Statement of Advice issued. There may also be implications around sourcing a suitable replacement, particularly for more specialised ETFs.

Of course, not all small-scale ETFs risk closure and other factors may provide ongoing support at the issuer level. Some issuers will maintain certain niche ETFs for strategic reasons, as the ETF is part of a broad product offering from a stable business.

Obviously, terminations are not limited to ETFs and are also common in managed funds. However, Zenith believes that strong growth in issuance increases product competition. As a result, we believe that more products will be rationalised in the future, and investors should consider the implications of an ETF's lifecycle and the quality of the issuer, not just the investment merit.

 

Dugald Higgins is Head of Property and Listed Strategies at Zenith Investment Partners. This article is general information and does not consider the circumstances of any individual.

 

RELATED ARTICLES

Does Bitcoin warrant a small allocation in portfolios?

Five steps to become a better investor

Six guidelines on how to allocate SMSF cash

banner

Most viewed in recent weeks

Australian house prices close in on world record

Sydney is set to become the world’s most expensive city for housing over the next 12 months, a new report shows. Our other major cities aren’t far behind unless there are major changes to improve housing affordability.

The case for the $3 million super tax

The Government's proposed tax has copped a lot of flack though I think it's a reasonable approach to improve the long-term sustainability of superannuation and the retirement income system. Here’s why.

Tariffs are a smokescreen to Trump's real endgame

Behind market volatility and tariff threats lies a deeper strategy. Trump’s real goal isn’t trade reform but managing America's massive debts, preserving bond market confidence, and preparing for potential QE.

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

The super tax and the defined benefits scandal

Australia's superannuation inequities date back to poor decisions made by Parliament two decades ago. If super for the wealthy needs resetting, so too does the defined benefits schemes for our public servants.

Getting rich vs staying rich

Strategies to get rich versus stay rich are markedly different. Here is a look at the five main ways to get rich, including through work, business, investing and luck, as well as those that preserve wealth.

Latest Updates

The revolt against Baby Boomer wealth

The $3m super tax could be put down to the Government needing money and the wealthy being easy targets. It’s deeper than that though and this looks at the factors behind the policy and why more taxes on the wealthy are coming.

Superannuation

How to prevent excessive superannuation balances

There is an alternative, simpler approach which could be used to mitigate some of the difficulties that the proposed super tax has for holders of large assets such as properties, businesses and farms in SMSFs.

Shares

US shares: Ambitious multiples on ambitious EPS forecasts

Here's a detailed look at how current valuations and profit forecasts for the S&P 500 stack up versus history. The answer? Both seem excessive, making the market vulnerable to a correction or worse.

Taxation

Family trust tax: When is a loan not a loan?

A recent ruling could change the tax payable by beneficiaries of family trusts. If the ATO has previously demanded extra payments on unpaid present entitlements in your family group, you should watch this space.

Property

Things you must consider before subdividing a property

Subdividing can offer a lucrative first step into property development. Yet it comes with legal, planning and unexpected tax considerations that should be understood from an early stage to avoid surprises.

Investment strategies

5 insights that put market volatility in perspective

Though it may feel like this time is different, markets have shown resilience throughout history when confronted by wars, pandemics and other crises. In many cases, the best course of action has been none at all.

Strategy

Concerns about China's rise to power seem overblown

China has always managed its affairs in a very different way to Western countries and empires. For those concerned about China's rise as a global power, the big question is whether this approach could change.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.