6 new sector ETFs

From Michelle Morgan, Aii

The Australian Exchange Traded Funds (ETFs) market continues to grow rapidly. The combined market capitalisation of ASX-listed ETFs increased from $1.21 billion in January 2009 to $2.9 billion in January 2010 - a 140 per cent gain.

More ETFs continue to be listed on ASX, the latest being sector ETFs from Australian Index Investments (Aii). It will list six sector ETFs in April:

• Aii S&P/ASX 200 Financials Fund (ex A-REITs) index (ASX code: FIX)
• Aii S&P ASX 200 Energy Fund (ENY)
• Aii S&P/ASX 200 Financials Fund (FIN)
• Aii S&P/ASX 200 Industrials Fund (IDD)
• Aii S&P/ASX 200 Resources Fund (RSR)
• Aii S&P/ASX 300 Metals and Mining Fund (MAM)

Sector ETFs are an important development because they enable investors to take a view on individual Australian sharemarket sectors. The 25 ETFs or Exchange Traded Commodities (ETCs) listed on ASX currently cover international indices, local market indices (the top 50 or 200 Australian shares), or ETCs over gold, silver, platinum, palladium, or a basket of commodities.

Four sector ETFs are currently listed on ASX. Three are based on global sector indices, and one, from State Street Global Advisors, covers the S&P/ASX 200 AREIT index.

ASX Investor Update's Tony Featherstone spoke to Michelle Morgan, Aii sales and marketing manager.

ASX Investor Update: Michelle, why is Aii listing six sector ETFs?

Michelle Morgan: The Australian ETF market is following trends overseas where ETFs are widely used by retail investors, financial advisers and institutional investors. Aii identified a gap in the Australian ETF market for a product that lets investors take a view on individual sharemarket sectors. We believe sector ETFs nicely complement ETFs from other issuers that let investors get simple, transparent exposure to international markets, or the top 200 companies, for example.

ASX Investor Update: How will Aii sector ETFs work?

Michelle Morgan: Like all ASX-listed ETFs, you buy and sell Aii sector ETFs just like a share. Take Aii S&P/ASX 200 Financials Fund (ex A-REITs) [code: FIX] as an example. An investor with a positive view on the financial sector may traditionally buy some bank shares. Another option is buying FIX and getting exposure to a basket of financial companies. Through a single purchase, the investor gets exposure to the Commonwealth Bank, Westpac, National Australia Bank, ANZ, QBE Insurance Group, Macquarie Group, AMP, Suncorp-Metway, Insurance Australia Group, and AXA Asia Pacific Holdings. These 10 make up 94 per cent of the weighting in this particular index.

ASX Investor Update: What are the main benefits of sector ETFs?

Michelle Morgan: As the example above shows, Aii sector ETFs provide instant, low-cost diversification in a particular sector. They also give investors all the benefits of owning underlying shares, such as dividends, distributions, and associated franking credits. Also, Aii sector ETFs remove the need for company-specific research; you form a view on the prospects for the sector as whole.

Although ETFs are a passive investment, which means the price and dividends follow an index, they can also be used as 'satellite' investments with the potential to outperform the market. For example, an investor may believe the resource sector has run too hard, and that financials will outperform this year.

ASX Investor Update: What do Aii sector ETFs cost?

Michelle Morgan: The average management fee of the six Aii sector ETFs is 0.43 per cent per annum - much less than active managed funds that charge an average 1.75 per cent per annum. The management fee is low because of low portfolio turnover in Aii sector ETFs. Of course, investors also pay brokerage fees when they buy or sell an ETF, as with shares.

ASX Investor Update: How does portfolio rebalancing affect Aii sector ETFs?

Michelle Morgan: This is an important point. Standard & Poor's rebalances the indices over which Aii sector ETFs are based each quarter. S&P removes underperforming shares and replaces them with outperforming ones. This automatic rebalancing means investors who hold Aii sector ETFs are getting the benefit of underperformers being weeded out of indices every quarter - a service that is covered by the 0.43 per cent management fee. An investor who drops underperformers from their own portfolio every quarter or six months has to pay brokerage and spend time choosing what to buy and sell.

ASX Investor Update: What about liquidity for ETF investors?

Michelle Morgan: Aii sector ETFs use a market-maker to ensure there is a buyer for every seller, which means liquidity is not a problem.

ASX Investor Update: What about portfolio duplication? Is there a risk investors double up on shares if, for example, they hold BHP Billiton and Rio Tinto directly, and buy the Aii S&P/ASX 300 Metals and Mining Fund (code: MAM), where BHP and Rio account for 69 per cent of the underlying index?

Michelle Morgan: It is something investors should consider. But using MAM as an example, the investor gets exposure to several other companies besides BHP and Rio in this ETF. The underlying index also includes Newcrest Mining, Lihir Gold, Fortescue Metals, Bluescope Steel, OneSteel and several other resource-related shares.

ASX Investor Update: What are the main risks with sector ETFs?

Michelle Morgan: As with any ETF, the main risk is that the sector in which you have invested does not perform to your levels of expectation. Because Aii sector ETFs provide sector focus, the risk is more concentrated than in, say, an ETF over the top 200 shares. Equally, there is more risk investing in a single share than in a sector ETF that provides exposure to a basket of shares. It depends on an investor's risk/return preferences.

ASX Investor Update: How can investors use Aii sector ETFs in their portfolios?

Michelle Morgan: They suit various investment styles. A Self Managed Super Fund (SMSF) investor may hold MAM for several years to get long-term exposure to mining shares. A portfolio investor may hold ETFs over international indices or the top 200 Australian shares in their portfolio 'core' to get Beta (the market return) and hold Aii sector ETFs as portfolio 'satellites'. An active investor may rotate between sectors using Aii ETFs every quarter or six months. A trader may buy Aii sector ETFs regularly to capitalise on short-term sector movements.

ASX Investor Update: Australian Index Investments is a new name to investors. Can you tell readers more about it?

Michelle Morgan: Aii was set up to launch ETFs in Australia. We are a wholly owned company based in Sydney that is part of the Eurofinance Group. Eurofinance has been issuing innovative share and debt instruments since 1988 and has stood the test of time through various market cycles. Aii plans to list more ETFs on ASX over time.

ASX Investor Update: How can investors get more information on Aii sector ETFs?

Michelle Morgan: They can view the Aii Fact Sheet for more information. Alternatively they can email: enquiry@aiifunds.com.au to be placed on our database for listing and research updates.

From ASX

For a list of all ETFs/ETCs listed on ASX, visit the ETF/ETC section of the ASX website. Read a detailed product description of ETFs on the ASX website.

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