5 things Australian investors still get wrong about ETFs

But even though the Australian ETF market has been around since the early 2000s, there are still many things that investors get wrong or don’t realise about ETFs.

For one, ETFs are used by everyone from first-time investors to sovereign wealth funds and financial advisers. In Australia, adoption has increased by 400% in under six years as investors look for transparent and flexible ways to build portfolios across multiple asset classes, regions and thematics.

Yet despite that growth, many assumptions about ETFs still reflect a misunderstanding of how the structure works.

Myth 1: “ETFs are riskier than owning individual shares”

For many investors, buying individual shares in companies like CBA or BHP feels familiar. But familiarity and risk are not the same thing.

A portfolio built around a handful of shares can be heavily exposed to the fortunes of those companies and sectors. An ETF, by contrast, can spread exposure across hundreds or even thousands of securities in a single trade.

At the same time, it is equally simplistic to assume all ETFs carry the same level of risk. The ETF market has evolved well beyond broad index-tracking strategies, with investors now able to access everything from conservative bond exposures to higher risk strategies such as thematics and cryptocurrencies.

Diversification alone does not automatically make a portfolio well-constructed either. In markets like Australia, some broad market indices can themselves become heavily concentrated in a relatively small number of companies or sectors over time. That has

contributed to growing investor interest in ETFs built around more deliberate exposures, including quality, equal weight, income and low volatility strategies.

Myth 2: “If an ETF doesn’t trade much, it must be illiquid”

A common misconception about ETFs is that if a fund does not trade heavily on the ASX, it must be illiquid or difficult to exit in volatile markets.

While that may be true for ordinary company shares, ETFs operate differently. Their liquidity is influenced not just by the number of ETF units changing hands on exchange, but by the liquidity of the underlying investments inside the fund.

An ETF holding large, frequently traded Australian or global shares may still be able to support significant trading activity even if its on-screen volumes appear relatively modest. This is because ETF units can be created or redeemed in response to investor demand through a process involving institutional trading firms known as authorised participants.

One of the other indicators investors often look at is the bid-ask spread: the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept. In highly liquid ETFs, spreads are often narrow, although they can widen during periods of market volatility or when the underlying assets inside the ETF are themselves less liquid.

For investors, the important point is that an ETF’s trading volume often tells only part of the story. Understanding the assets inside the ETF can be just as important as the activity visible on the screen.

Myth 3: “ETFs distort markets and create bubbles”

As ETFs have grown, so too has debate around whether they are contributing to market concentration, particularly in markets like Australia where a relatively small number of companies dominate benchmark indices. Commonwealth Bank (ASX: CBA) is often cited as an example. At various points in recent years, CBA traded at valuations that made it one of the most expensive banks in the world, prompting some commentators to argue that ETF inflows and passive investing were artificially pushing prices higher.

The reality is more nuanced.

Broad market ETFs generally reflect the structure of the market rather than create it. If a company becomes a larger share of the ASX 200, index-tracking ETFs subsequently allocate more capital to it because the benchmark weight has already increased. But concentration in Australian equities long predates the rise of ETFs. The dominance of banks and large resource companies has been a feature of the local market for decades.

What the debate has highlighted, however, is that market-cap-weighted indices are not necessarily neutral. They naturally allocate more capital to the largest companies, regardless of valuation. That is one reason many investors have increasingly looked beyond traditional index-tracking strategies toward equal-weight, quality and value approaches. While questions around price discovery are unlikely to disappear entirely, markets are still ultimately driven by investor behaviour, company fundamentals and capital flows – not ETFs alone.

Myth 4: “The cheapest ETF is automatically the best ETF”

The growth of ETFs has helped drive investment costs lower across the industry, which has generally been a positive outcome for investors. But management fees are only one part of the equation. Fees still matter, but judging ETFs primarily on who charges the lowest management fee can be an overly simplistic way to invest. Portfolio construction, index methodology, diversification and implementation all play an important role in determining investor outcomes over time.

The more important question is often whether an ETF provides the exposure an investor wants – and whether it delivers that exposure in a way that remains true to label across different market environments.

Myth 5: “All ETFs are basically the same”

The term ETF describes a structure, not a strategy. Comparing all ETFs purely on fees or short-term performance can therefore miss the bigger picture. In addition, while some ETFs track indices, others are actively managed portfolios wrapped inside the ETF structure.

What matters more than structure is understanding:

• what the ETF owns
• how the strategy or index is constructed
• how the fund may behave in different market environments
• the ETF’s role within a broader portfolio

As the ETF market has matured, investors have gained access not just to markets, but to increasingly sophisticated ways of building portfolios.

The bottom line

ETFs have reshaped investing because they combine accessibility, transparency and diversification in a structure that can be traded as easily as a share. But the investors who tend to use ETFs most effectively are usually the ones who look beyond the ticker code and understand the mechanics underneath it.