Boutique fund manager SG Hiscock has warned the rise of equity ownership by ETFs and index funds could see a drop in active governance from investors as well as decreasing capital distributed to start-ups and new “ideas”.
Australian ETFs surpassed $50 billion in July, with the sector growing by 25 per cent in the first half of the year. It ended October on $57.2 billion.
Currently, ETFs only make up 1.5 per cent of the Australian investment market, as shown by new BetaShares and Investment Trends data, but their joint report has predicted 135,000 investors will enter the market in the coming year and up to 58 per cent of current ETF investors will reinvest.
Stockspot has forecast Aussie ETF assets will reach $100 billion by 2022, doubling the industry’s size during the next three years.
A number of exchange-traded funds on the market have also presented themselves as ESG or responsible investing focused.
But Stephen Hiscock, chief executive of SGH has cautioned ETF providers lack active governance and engagement with companies to the same extent as active managers. The potential market takeover of ETFs could mean less accountability from shareholders.
“We vote on everything. Every single holding we have, we meet with the management, we talk to them about their resolutions in their AGMs and we vote,” Mr Hiscock said.
“The way a lot of the index funds and ETFs do it, if they vote at all, is they simply just follow the recommendation of whichever ratings agency they use to give them the recommendation and they don’t really spend a lot of time on governance.
“That’s something that’s been the case for ages, however it’s just a staggering increase in size that means an increasing portion of equity ownership is now subject to more passive governance elements. And that really concerns us because one of the key things we do as active managers is make sure the businesses do the right thing from an environmental, social and from a governance standpoint.”
Index funds, from a capital perspective do not tend to take up IPOs, Mr Hiscock noted, but he fears this may create a deficit in funding for newcomer companies in the future.
“For obvious reasons, they’re not part of the index, there’s active risk if they do take up IPOs and really what that means, the bigger they get, is there’s a scarcer source of capital for really good ideas,” he said.
“Now that’s great as an investment manager, as an active manager, maybe that means on balance we can look at more allocation, but from an industry perspective, the source of capital for new IPOs as a percentage of the overall market is drying up.”
Further, Mr Hiscock commented that the increase of ownership for ETFs with their growth could be cause for concern, with little room for liquidity and the concentration of certain stocks potentially impacting the market.
But he believes the gaps he has pointed to are opportunities for active fund managers to prove themselves in the coming years.
“We do think that long term, some of the ones with more esoteric or less liquid instruments in them are cause of concern, but obviously the ones that are just mirroring the ASX 200 or whatever are absolutely fine,” Mr Hiscock said.
“But the key issue we have as an active manager is that by definition, these groups are trend following, they’re only buying the stocks that are going up, they’re buying the stocks that have gained momentum and large market capital.
“The bigger the stock is, the more market capital, the more they buy of it. This has obviously been an issue for some time, but it’s the sheer size that is cause for concern.”
Sarah Simpkins is a journalist at Momentum Media, reporting primarily on banking, financial services and wealth.
Prior to joining the team in 2018, Sarah worked in trade media and produced stories for a current affairs program on community radio.
You can contact her on [email protected].