Exchange traded funds (ETFs) have become a significant feature of global financial markets. This blog explores the rise of ETFs and the implications of their rise for the NZ share market in the context of increasing foreign ownership.
What is an ETF?
An Exchange Traded Fund (ETF) is an investment fund traded on a stock exchange much like stocks. ETFs hold assets such as stocks, bonds or commodities and typically track an index (for example the S&P 500 stock index in the US).
ETFs are useful because they provide an easy way (and often efficient, low cost way) for an investor to gain exposure to a whole asset class, country, region or style of investment without having to invest in all of the underlying securities.
The popularity of ETFs as investments has soared over the past decade. Global ETF assets have increased from US$400 billion in 2005 to over US$4.6 trillion as of Aug 20161 with the number of ETFs available increasing from 450 to 32091 in the same period.
Why is this of importance to NZ?
The rise in popularity of ETFs has coincided with the trend for increasing foreign ownership of NZ stocks (from around 30% in 2012 to almost 50% now2). ETFs make up a significant portion of foreign ownership of the NZ market so it is instructive to understand the trends in these types of investments.
Foreign ETF investment in NZ increases by two methods:
- Additions of NZ companies to ETFs, typically because NZ companies are added to global stock benchmarks (as they reach a certain size) or because NZ companies satisfy a particular investing criteria (for example a high dividend yield).
- Incremental inflows to ETFs that already own NZ companies
Both of these factors have provided inflows to NZ from global ETFs over the past few years and therefore will have contributed to the performance of the NZ share market. NZ share market performance has meant more NZ companies have been added to global stock benchmarks and the high dividend yield nature of NZ shares has played to the recent trend of owning shares for income purposes.
Using available data3 we believe it is reasonable to assume that ETFs own up to 4.5% of the NZ market (although this could be much higher for certain stocks). Additionally, the movement of ETF holdings in NZ is likely to mirror offshore investor behaviour for a much larger proportion of the market (representing passive offshore investors in NZ).
Is ETF ownership of NZ shares likely to increase or decrease from here?
Examining the drivers of the trends in ETFs leads us to the following conclusions:
- At a global level, assets under management of ETFs is expected to continue to increase, driven by regulation in the US4 and the continued trend to lower the costs of investing.
- Representation of NZ stocks in global benchmarks has increased dramatically over the past few years but it is reasonable to assume that there is still room for further additions, although the pace of additions is likely to be much reduced.
- A large proportion of ETF ownership of NZ is tied to the high dividends available and the degree to which this attribute is sought after. At Milford we think NZ dividend yields are sustainable and we also expect income shares to remain in demand in a low growth global environment.
For these reasons we expect ETF ownership of NZ companies to continue to increase but the significant proportion of foreign ownership of NZ means we monitor flows in ETFs very closely. The last 6 months have seen strong inflows into ETFs holding NZ shares. These have moderated in the past month but we are yet to see significant outflows5.
- We see ETFs continuing to grow in popularity and we believe that ETF ownership of NZ shares is a feature of our market that is here to stay.
- If they do indeed become a significant proportion of ownership (and potentially even larger proportion of the daily trading activity) it is prudent that NZ investors monitor the trends.
- Our view is that longer term trends point to increasing ETF ownership of NZ.
- In the short term, we see a moderation in the level of inflows.
- Data from ETF research and consultancy ETFGI (www.etfgi.com)
- Data from Forsyth Barr research (Note published 15th Sep 2016 titled “Keep an Eye on the Aussies”)
- Using shareholder data from Bloomberg and analysing the holdings from the large global ETF providers such as Blackrock and Vanguard.
- Madison Marriage, “Obama’s ‘fiduciary rule’ adds to active fund woes”, https://www.ft.com, (September 11, 2016)
- Milford research using available holdings data from ETF websites and Bloomberg, selecting ETFs that own NZ companies and monitoring in/outflows of these ETFs over different periods.
Disclosure of interest: All Milford funds are able to invest in ETFs and of these, the Global, Balanced, KiwiSaver Balanced, Active Growth, KiwiSaver Active Growth, Conservative and KiwiSaver Conservative Funds currently hold ETFs.
Disclaimer: This is intended to provide general information only. It does not take into account your investment needs or personal circumstances and so is not intended to be viewed as investment or financial advice. Should you require financial advice you should always speak to an Authorised Financial Adviser.