Hush Puppies and the Hayne Royal Commission

It has been well documented that ETF adoption in Australia has lagged the rest of the world. According to ETFGI, at 31 March 2018, ETF assets in the US totalled US$3.45 trillion (A$4.42 trillion). In Europe that figure was US$785 billion (A$1.02 trillion) and even Canada had US$118 billion (A$151 billion) invested in ETFs. At the same time, in Australia, which boasts the 2^nd largest pension market in the world, the ASX reports that the amount invested in its listed ETPs, which predominately includes ETFs, is just A$36.6 billion.

There have been a number of reasons for the relatively slow adoption rates among Australian investors. However, the Tipping Point, that magic moment, when ETFs “cross the threshold, tip and spread like wildfire” could be happening soon and the Royal Commission could be the spur.

In The Tipping Point: How Little Things Can Make a Big Difference, Malcolm Gladwell analyses the dramatic moment in an epidemic when everything can change. This is known as the ‘Tipping Point’. According to Gladwell there are three rules for a Tipping Point which helps identify them. They are:

1. The Law of the Few – it only takes a small group of people to create a Tipping Point, provided they have the power to persuade people;
2. The Stickiness Factor – the message has to be memorable; and
3. The Power of Context – the environment has to be right.

The Law of the Few

Gladwell uses the resurrection of the American shoe brand Hush Puppies as an example. A scattering of well-connected New Yorkers started seeking out Hush Puppies from thrift and second-hand stores just as their maker, Wolverine, considered halting production due to poor sales. These few trend-setters set off a chain of influence getting the shoes noticed and worn by fashion designers and Hollywood stars. Sales went from around 30,000 in 1994 to 430,000 in 1995.

ETFs in Australia are being used by trend-setters. There are a large number of well-connected and influential financial advisers, brokers and self-directed individuals already using ETFs in Australia. And their numbers are increasing. Gladwell’s first law is met. The growth of ETFs in Australia is illustrated by the light blue line in the graph below.

_{Source: ASX, March 2018. ETFs make up 91% of the ETP market capitalisation and 81% of the total number of ETPs listed.}

The Stickiness Factor

ETFs also meet Gladwell’s second rule. The message that ETFs carry is quite memorable. ETFs offer:

• Lower fees than actively managed funds;
• Greater transparency - you see all your holdings on a daily basis and can see live prices on ASX;
• Tax efficiency; and
• Liquidity – you buy and sell on exchange as simply as trading shares.

While passively managed ETFs have lower costs than actively managed funds, they more often than not have also outperformed their actively managed peers. This is highlighted time and time again by S&P Dow Jones Indices’ SPIVA scorecard. The most recent one, for example, for the period ending December 2017 reveals that nearly 60% of active Australian equity managers were outperformed by the S&P/ASX 200 Accumulation Index over the previous twelve months. Over longer time periods this lack of performance is far more pronounced, with almost 74% and 77% of active managers being outperformed by the benchmark over 10- and 15-year periods respectively.

Investors will not stand for this anymore. More and more investors are adopting low-cost ETFs as a first choice over actively managed funds.

Passive funds do not just mean ‘market’ returns minus fees. Smart beta ETFs go beyond simple benchmarks and implement proven institutional grade rules-based investment approaches. Examples include our own VanEck Vectors Australian Equal Weight ETF (ASX: MVW) and VanEck Vectors MSCI World ex Australia Quality ETF (ASX: QUAL) which have performed strongly since their inception. Their indexes have both demonstrated historical outperformance compared to both their market benchmark and their active peers.

_{MVW Inception date is 4 March, 2014. QUAL Inception date is 29 October, 2014.
Source: Morningstar Direct, to 30 April 2018. Results are calculated daily and assume immediate reinvestment of all dividends. MVW and QUAL results are net of management fees and other costs incurred in the funds but do not include brokerage costs or buy/sell spreads incurred when investing in MVW and QUAL. Past performance is not a reliable indicator of future performance.}

The Power of Context

For a Tipping Point to be reached the conditions and the circumstances have to be right. Up to now the message of better performance at a lower cost has not been enough to move the bulk of the money. The answer to this conundrum has been provided by the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. The evidence to date suggests that the interests of the shareholders in the big integrated financial institutions have been put first, not the interests of clients. The environment has not been right for ETFs because of these conflicts of interest. We expect after Commissioner Hayne hands down his findings that clients and indeed regulators and the legislators will no longer stand for these conflicts which have led to breaches of clients’ trust and high fees that have made these institutions wealthy. Clients will be asking their advisers, if they are not in non-conflicted low-cost ETFs, why not?

The Power of Context has been the characteristic missing for ETFs to achieve their Tipping Point. We expect a legislative overhaul following Commissioner Hayne’s findings. Community expectations have changed. The revelations that have been detailed at the Hayne Royal Commission must bring about the end of conflicts of interest that large, vertically integrated institutions currently have. This is going to result in changes to how financial advice is given in Australia and how products that satisfy clients’ best interests are identified.

ETFs will hit a Tipping Point and there will be unprecedented growth. Smart beta ETFs will be at the forefront.

_{IMPORTANT NOTICE: This information is issued by VanEck Investments Limited ABN 22 146 596 116 AFSL 416755 (‘VanEck) as the responsible entity and issuer of the VanEck Vectors Australian domiciled exchange traded funds (‘Funds’). Nothing in this content is a solicitation to buy or an offer to sell shares of any investment in any jurisdiction including where the offer or solicitation would be unlawful under the securities laws of such jurisdiction. This is general information only and not financial advice. It does not take into account any person’s individual objectives, financial situation or needs. Before making an investment decision in relation to a Fund, you should read the applicable PDS and with the assistance of a financial adviser consider if it is appropriate for your circumstances. PDSs are available at www.vaneck.com.au or by calling 1300 68 38 37. The Funds are subject to investment risk, including possible loss of capital invested. Past performance is not a reliable indicator of future performance. No member of the VanEck group of companies gives any guarantee or assurance as to the repayment of capital, the payment of income, the performance, or any particular rate of return from any Fund.}