ETF Q&A

Investors at our ETF trading strategies webinar asked many thoughtful questions that we didn’t have a chance to cover including about ETF investing via SMSFs; how dividends/franking credits in ETF work; and queries about trading ETFs with nabtrade.

BlackRock iShares’ Paula Gigler (PG) and Morningstar’s Alex Prineas (AP) cover those queries below. Additional responses on ETF queries on nabtrade are provided by our Head of Product, Brett Grant (BG).

DIVIDEND & REINVESTMENT PLAN QUESTIONS

Question: Do ETFs provide dividends and franking credits, as well as capital gains?

PG: Yes. Dividends (if declared) are distributed to investors in an iShares fund on the payment dates relevant to each fund. Declared dividends are generally paid on a quarterly or semi-annual basis, depending on the fund. Full details of distribution dates are provided on the iShares website. Franking credits only apply to Australian equity iShares. In general, available franking credits are passed on to the end investor.

BG: Where an ETF pays dividends, you can instruct the registry to make cash payments into your nabtrade Cash Account or bank account of choice (just like with individual shares that pay distributions). You can use nabtrade’s Dividend Crediting function to redirect dividend payments into the nominated cash account on your behalf.

Question: How do dividend payments with international ETFs work?

PG: The same as your normal dividends from direct shares. The registry will distribute the dividends on the payment date for the relevant ETF, however there are no franking credits with international equity ETFs.

BG: If you invest in international ETFs via nabtrade then dividends are credited to your Cash Account. The Foreign Withholding Tax is automatically deducted from the payment. To be sure, you cannot participate in a dividend reinvestment plan on international ETFs via nabtrade.

Question: How do you determine income / dividend-paying ETFs when the nabtrade platform does not always show dividend payments?

PG: You can look at the ETF provider website, for example, if you look at IOZ:ASX (the ASX200 ETF) on the iShares website here, you’ll see the current yield is 4.95% (as at 15/8/19) on this page and the last distributions.

Question: If you reinvest your dividend, will another share in your fund be automatically purchased?

PG: DRP (dividend reinvestment plans) are available now all iShares ETFs. You can access more information here about DRP. Units will be allocation depending on the dividend, any residual cash will be held and applied to the next dividend.

ETFS STRUCTURE & LIQUIDITY QUESTIONS

Question: Are there any differences between how an ETF and the equivalent index fund perform in a market crash?

PG: The key difference is that the ETF is listed on the ASX and the fund is not. The job of any index product is to track the index, so regardless of whether you buy the ETF or the fund, the manager’s role is to track the index as closely as possible.

Question: What is your view on potential liquidity risks on the underlying investments of ETFs, especially on levered ETFs?

PG: An ETF is as liquid as the underlying securities. When you add leverage or synthetic investments to an ETF you change the liquidity profile. iShares does not provide these types of investments in Australia.

Question: Is the number of market makers important in determining an ETFs liquidity in a market stress event? If an ETF has just one market maker vs say three market makers, what conclusions should an investor draw?

PG: An ETF is as liquid as the underlying investments and iShares strongly advocate for a multi market maker environment. The role of multiple market makers is to keep the price close to the NAV (net asset value).

Question: Does an ETF fund own the shares under it?

PG: There are two types of ETFs: physically backed and synthetic. iShares does not have any synthetic ETFs in Australia. Physically backed ETFs own the underlying securities.

ETF TAXATION QUESTIONS

Question: What are the capital gains tax implications of buying and selling ETFs?  How long must you hold them to avoid or reduce tax?

PG: You need to consult your accountant for advice on tax. However capital gains tax should apply the same as any security you purchase on the ASX. You may also need to consider tax on any income.

Question: The taxation implications are very complicated for ETFs. One needs to wait for the annual statement which is sent to investors a long time after the end of the FY. Is there a simpler process?

PG: You can look at the ETF provider website, for example, if you look at IOZ (the ASX200 ETF) on the iShares website here, you’ll see the most recent distributions and there is a schedule for upcoming payments also.

GENERAL ETF INVESTMENT QUESTIONS

Question: What is the minimum amount you need to trade ETFs?

BG: For an ASX listed company or ETF the minimum order size for the first trade is $500 worth of units. This is known as the minimum marketable parcel. There is no minimum unit amount or value for the NYSE, NASDAQ, AMEX or XETRA market. For trading on the HKSE, each trade has to be in multiple of lot size. 

Question: Are ETFs suitable for self managed superannuation funds? What should a SMSF retiree look for in an ETF?

PG: ETFs may be suitable for all investors, but we’d suggest looking at your risk profile first to determine which ETFs are most suitable for you. You can use our core builder tool here to build a portfolio based on your risk profile. Before making any investment decision, you should assess whether the material is appropriate and take appropriate professional advice tailored to you having regard to your individual objectives, financial situation, needs and circumstances.

Question: Question for Alex - what management fee would you consider 'average' for an active ETF?

AP: Fees for actively managed ETPs are roughly comparable to unlisted active funds, with a base fee often above 1%. Many active funds also charge a performance fee. In that instance, Morningstar analysts prefer to see a substantially lower base fee, so that investors don’t overpay when the fund underperforms, but might pay more when the fund delivers on its objectives. We also look for appropriately structured performance fees that include features such as a high watermark, and an appropriate hurdle rate.

Question: As a young investor, are ETFs a good way to begin a portfolio with limited funds?

PG: We do see a lot of clients using them as a tool to start building portfolios for smaller balances. For example, buying IOZ (ASX200 ETF) gives you 200 stocks in one trade, rather than trying to buy all 200 if you only have a small amount to start with.

Question: Are there any red flags, warning signs or things to look out for when buying lesser known ETFs?

AP: Assuming that you’ve done your research and are comfortable that an ETFs investment strategy is appropriate for your financial situation and goals, there are a few things to look out for beyond that. At Morningstar we’ve published a few research pieces on various topics around investing in lesser known ETFs.

‘Terminator ETFs’ are one example. These are small ETFs that are unlikely to ever get sufficient scale, and might get closed down by the ETF manager. More than two dozen ETFs have been closed down in Australia since 2013, out of about 200 total listings.

When an ETF is closed down it is usually not a disaster, but when your money is returned to you it can be inconvenient, may have tax consequences, or transaction costs. So no matter how great an ETF’s investment strategy is, if the ETF gets shut down it may not be ideal.

Another thing to look out for with lesser known ETFs is that smaller ETFs may in some instances have lower liquidity. It is true that the biggest factor in liquidity is the underlying asset class, not the ETF itself. But it can help if the ETF is larger. We’ve discussed these topics regularly in Morningstar’s ‘ETF Investor’ quarterly newsletter.

Question: If ETFs do well in bull markets, then do they perform poorly in bear markets? How should I think about this risk?

PG: ETFs track an index, they will do what that index does in all market scenarios. For example, IOZ (ASX200 ETF) will go up when the ASX200 does and down when the ASX200 does. The question to ask yourself is ‘what is my risk tolerance?”’ then choose the appropriate ETF for you.

Question: How do you determine when a particular ETF is good value for money?

BG: We encourage nabtrade customers to view information in the ‘Research’ tab when looking at an ETF in their account. This section provides valuable information from Morningstar on ETFs including fees and how those costs stack up against competing funds.

Question: In the ETF 101 webinar it was suggested that we place Limit orders.  Can you expand?

PG: When trading an ETF on nabtrade or your online broker, you can set a price limit. I.e. set the exact price you want to purchase or sell the ETF for.

AP: Limit orders help ensure favourable execution from a price perspective. A buy limit order will fetch the buyer a price less than or equal to the limit price, while a sell limit order will transact at a price greater than or equal to the limit price. We advocate using limit orders for ETFs, not market orders. We discussed this in Morningstar’s ‘10 Tips for Trading ETFs’ article.

Question: Are there ASX-listed ETFs that offer exposure to high grade corporate/govt bonds in USD?

PG: Yes, iShares have IHCB which is the Global Corporate Bond ETF, which is 52% US based bonds (at the time of writing). This is investment grade corporate bonds but no government bonds.

Question: How do we know what fees are charged by ETF and what is included inside those ETFs? Are ETFs equally weighted or is it based on market cap of companies inside those ETFs?

PG: When purchasing or selling an ETF, there are a couple of fees to consider:

1. MER – management fee
2. Trading costs

The construction of an ETF will depend on the index, i.e. market cap weighted, equal weighted or rules based. The Morningstar research or the ETF provider website will tell you this. Most of the ETFs on the ASX are market cap weighted.

AP: Reading the PDS (product disclosure statement) is the best way to check the fees and other costs.

Morningstar’s fund analysts will usually add context in their reports. For example they may comment on how costs compare to rival ETFs or funds. If there is a performance fee, our analysts will usually comment on the amount, and may comment on flaws or advantages in its structure.

In addition to ongoing fees disclosed in the PDS, there are also costs to transact ETFs, including brokerage, and bid/ask spreads (which can vary day to day or minute to minute). This is too large a topic to discuss here, but Morningstar analysts often discuss bid/ask spreads in their research reports, or in more in-depth articles.

BG: On nabtrade, you can view fee and portfolio information on individual ETFs. When you select an ETF click on ‘Research’ to access Morningstar information on fees, and ‘Portfolio’ to see an overview of what the ETF holds.

Question: Does BlackRock have any listed multi asset ETFs that include fixed income, international equities etc all in one ETF?

PG: We don’t at this stage, however you can use our core builder tool here. This will build a multi asset portfolio for your risk profile and show you which ETFs to combine.

Question: I’d like to understand the fee structure of multi-asset ETFs. For example, Vanguard’s Diversified Balanced Index ETF charges an MER of 0.27%. Is that fee on top of the fees charged by the underlying investments it makes?

AP: This question is best directed to Vanguard for a full answer. The 0.27% fee should be the total fee charged by Vanguard, including the cost of any underlying funds managed by Vanguard.

There will be costs incurred by the companies in the portfolio (shares, bonds etc.), as companies generate revenue and have expenses. But that is the same as if you held the shares directly anyway.

Question: Is there a full range of International ETF's that can be accessed via this platform?

BG: We offer ETFs listed on NYSE, NASDAQ, AMEX and the XETRA market and HKSE.