This article appeared in the July 2013 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
From humble beginnings on ASX, ETCs have become a global phenomenon. See what's next, and whether gold can recover lost ground.
ETF Securities founder Graham Tuckwell might be known by many for donating $50 million of his personal wealth to Canberra's Australian National University in February this year - the largest donation made to an Australian university but it was listing on ASX of his firm's gold exchange-traded commodity in 2003,which paved the way for a billion-dollar global ETC industry.
Having worked in investment banking and as a resource specialist, Tuckwell saw a need for listed products that gave investors exposure to pure commodities via ASX. He believed investors who sought exposure to a higher gold price should have other options beyond buying gold stocks.
Exchange-traded commodities (ETCs) track the underlying performance of a physical commodity or index, letting investors gain direct exposure to the underlying asset without taking physical delivery of the commodity or trading futures contracts.
Put simply, an investor who believes the gold price will rise could buy a gold ETC in preference to buying a gold stock, which has company, sharemarket and other risks. Buying a gold stock makes sense if the investor has a positive view on the company, but ETCs provide purer commodity exposure (currency risk is also an issue for ETCs that are not hedged for currency movements.)
A subdued start
The ETF Securities gold ETC had a subdued start upon listing because Australian investors were unfamiliar with trading commodities on stock exchanges. At the time, most global stock exchanges only traded stocks; ASX was one of the few to allow trusts (principally Australian Real Estate Investment Trusts, or A-REITs) to trade. Tuckwell also listed the gold ETC in London later in 2003 and it took off.
Ten years later, ETF Securities had US$23.2 billion in assets under management through its ETCs (at June 2013), 350 ETCs listed on 10 global exchanges, and about 90 employees. Its ASX-listed gold ETF is capitalised at $554 million.
Tuckwell is best known for donating $50 million of his personal wealth to Canberra's Australian National University in February this year - the largest donation made to an Australian university.
To mark the 10th anniversary of the gold ETC listing on ASX, ASX Investor Update asked Tuckwell about the outlook for exchange-traded commodities and metal prices, especially gold.
ASX Investor Update: Graham, the ASX-listed exchange-traded product (ETP) market had a combined market capitalisation of $7.7 billion in May 2013, ASX data shows, and is growing quickly. But it is small compared to a multi-trillion-dollar global ETP market. Why have Australian investors been slower to embrace index funds compared to overseas investors?
Graham Tuckwell: It's a good question and one that has frustrated me for years. Three reasons stand out. First, Australia has a long history on punting on resource stocks. For decades, investors have been conditioned to believe that if they think gold, oil, copper or other commodities are going up, they should buy a stock that produces the commodity.
Not enough investors realise that buying a resource stock does not give you pure commodity exposure; with it comes company risks, such as poor production figures, lower-than-expected grades, or management issues. Gold is a classic example: the gold price rallied last decade, but gold shares prices mostly fell.
The second reason is a history of investing in active funds over index funds, such as ETCs. Plenty of research worldwide shows active fund managers [who try to outperform their relevant sharemarket index] mostly underperform the market over time, after fees.
Only a small majority consistently outperform their index, yet investors pay high fees each year for a product that on average produces a lower return than the index. If you were to design the managed funds industry from a blank piece of paper today, there is no way you would have so many active funds all trying to beat the market, and charging high fees in the process. You would have mostly index funds that aim to replicate the index return at low cost.
The third reason is financial intermediaries. Brokers and financial advisers for decades have recommended stocks and active managed funds. Exchange-traded commodities, which do not offer ongoing commissions to advisers, had less appeal compared to active funds that paid commission. Thankfully, that is changing with the move to ban trailing commissions on managed funds.
ASX Investor Update: What will be the catalyst for index funds taking off in Australia?
GT: Education, pure and simple. Generations of investors have been told to buy stocks or funds for their portfolio, even though studies show asset allocation - not stock or fund picking - accounts for 80 per cent of returns. It will take time, but we need to help small investors understand they should focus on getting the right allocation of assets in portfolios - be it shares, bonds, cash or commodities - for their investment needs and timeframe, and using low-cost index products to execute and maintain that asset allocation over time. We have to move away from the notion of focusing most effort on picking actual stocks or funds, and spend much more time on the allocation of assets.
ASX Investor Update: Commodity prices have tumbled in the past year, leading some commentators to question whether the commodity boom is over this decade. Gold has been especially weak. Why would someone invest in commodities when many of them seem to be in well-established price downtrends?
GT: There are two key arguments. First, putting aside short-term price moves, there is a strong reason to have some commodity exposure in portfolios, to improve diversification. We tell investors to put 5-10 per cent of the portfolio in gold via our ETC, and hope it is the worst-performing asset in their portfolio. If gold performs poorly, that usually means the rest of their portfolio is doing well. They need to think of gold as a form of portfolio insurance that rises when everything else tanks.
Second, I'm not convinced the long-term uptrend in commodity prices is over. We could see further prices falls in the short term; commodities ran so fast during the boom that large falls are inevitable. Longer term, the core drivers of commodities - central banks printing more money and growth in emerging markets - are still strongly intact.
Take gold as an example. All the problems that led to the GFC are still there. Central banks are still printing more money and showing poor financial discipline. Higher inflation is still a key medium-term threat. Although gold might fall further in the short-term, the medium-term outlook is still positive, in my view, given expectations of higher inflation thanks to central banks flooding the world with money (Editor's note: gold is often bought as a hedge against rising inflation).
With base metals, China will still consume vast amounts of commodities, even as its growth slows. The market is obsessed with slowing growth in China, but forgets that its lower growth is now coming from a much larger economy. And we still have India and other large emerging countries to kick in and drive sharply higher demand for commodities in the medium to long term.
Exchange Traded Products Asset Classes explains the features, benefits and risks of ETCs. Twenty-five ETCs, from four issuers, were listed on ASX in May 2013.
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