Trends in the Australian ETF market

Investment in Australian Exchange Traded Funds (ETFs) surged in 2024 to reach $200 billion in Funds Under Management, representing a 20-fold increase in market size over the last decade. As the ETF market grows, so too does the range and sophistication of products on offer, attracting increased interest from institutional investors.  

In this article, we explore the use of ETFs among individual and institutional investors, the important role market makers play in providing liquidity and maintaining fair value and what’s next for the Australian ETF market.

Why use ETFs?

ETFs offer a low cost and efficient way to gain exposure to a diverse range of assets, regions, companies and strategies. The liquidity and flexibility of ETFs has made them one of the most popular on exchange investments with 20% of retail investors (1) now embracing the convenience of this product class. Noting that there are risks associated with any investment (2).

In Australia, there are three broad categories of ETFs covering shares, fixed income and commodities. Within each category there are targeted segments or exposures which range from simple to complex. Graham O’Brien, Head of Equity Sales and Derivatives at ASX explains. “The local market has seen phenomenal growth with a 36% increase in Funds Under Management on last year. We know that around half of this flow has been directed to overseas exposure, while the remaining 50% is split evenly between domestic equities (25%) and commodities and fixed income (25%). Investments can range from simple equity index tracking strategies to crypto currency to more targeted exposure to debt or leverage”. 

More recently, the Australian ETF market has seen escalating interest from institutional investors looking to take advantage of the liquidity and flexibility that these exchange traded products provide.

According to Chad Hitzeman, Head of Institutional at Global X ETFs, the ETF market opens access to a different investment universe. “There are roughly 380 ETF’s offering an extensive library of solutions across assets. The liquidity and transparency of the ETF market means that at times the ETF can offer better price discovery than the underlying assets themselves,” he says.  

While individuals may be more likely to adopt buy and hold strategies or use ETFs to gain exposure to certain sectors or themes, institutions may use ETFs to manage their portfolios in a strategic and efficient manner. 

Stephen Ead, Head of Global Product Solutions at BlackRock, believes the flexibility of ETFs is driving interest from the institutional market. “Large investors can use ETFs in a variety of ways, including managing daily cash flow, maintaining market exposure when transitioning between managers, or for investment strategies that are hard to replicate directly or with derivatives, such as global corporate bonds.”

The role of market makers

Each Australian ETF must have at least one market maker that is contractually obligated to provide prices at a certain volume and within a defined bid-ask spread. Market makers play a crucial role in maintaining a liquid and fair value ETF market. Blair Hannon, ETF investment strategist at Macquarie Asset Management, explains, “[We] work with market makers to make sure ETFs trade to Net Asset Value (NAV). If investors can’t trade to NAV, then this becomes an issue.”

Hitzeman believes market makers are a crucial element in the ETF ecosystem. “Any mismatch between on market price and Net Asset Value can be aligned by market makers through the creation and redemption process,” he says. 

Market makers are incentivised to price out any differences between underlying securities and ETFs which allows investors to trade with confidence, knowing that the ETF should be reflective of fair market value. 

For institutional investors, liquidity is key. Managers are often trying to balance the competing demands of having sufficient cash reserves whilst maximising returns. Raising and investing cash via the creation and redemption process is relatively quick and efficient allowing managers to minimise down time, particularly where they might be transitioning between managers or changing investment strategies.  

Access to ETF trading liquidity and tight bid-ask spreads means that it may be quicker and more cost-effective to buy the ETF rather than all the underlying securities themselves. In Ead’s view, this is one of the major benefits of trading ETFs, as investors can save on cost with no need to pay purchase fees on the individual assets. “When looking at Australian equities, ETFs trade as much as 6 basis points lower than buying the underlying securities, representing a substantial cost saving for our clients,” he says. 

Future trends

Despite its recent growth, the ETF market in Australia is still relatively small when compared to other investment classes. O’Brien puts this into perspective. “Around $500 million goes through in ETF’s each day which is equal to 10% of all daily turnover on the ASX,” he says. 

Hannon sees increased active management as the next big phase in ETFs. ASX data shows that index tracking ETFs remain the most popular investment however, the recent surge in active listed ETF’s may indicate a new trend. In the first half of 2024, 68% of Australian ETF’s listed were actively managed (3). 

Providers are already using innovative strategies to encourage new investors to explore active ETFs including low base fees with a larger performance fee. Hannon anticipates growth in active strategies will be further supported by the evolving sophistication across the ETF market. “As sophistication rises that helps everyone, including institutions, get access to better products,” he says.