AFR ETF series: mining

Smart Money, Australian Financial Review, April 2011

Exchange-traded funds (ETFs) started off in Australia by giving investors cheap and easy exposure to stock market indices like the S&P/ASX200. One of the ways they’ve evolved since then is with sector-specific ETFs – and none have proven more popular with issuers than those related to energy and resources.

There are several of these products available now. Australian Index Investments launched six sector ETFs just over a year ago, including one for metals and mining, one for energy companies, and one for resources – a combination of the other two. Then in December BetaShares, a new player in the Australian market but backed by the big Canadian ETF issuer BetaPro Management, launched a similar resources ETF. Next, in March, State Street Global Advisors, which launched the original SPDR ETF in Australia, announced three new funds, again including a resources product.

The selling-points of ETFs are well-known. They are cheap (for example, the BetaShare product has a management fee of 0.39%, Aii 0.43%, and State Street 0.4%). They are a very simple way of getting diversified exposure: you buy and sell them like any other stock but gain access to a whole portfolio of stocks. Planners like them because you can use ETFs to get core, index exposure, and then use specialist fund managers for active bets around the edges of a portfolio. And increasingly, they can be leveraged, if that appeals.

But what about playing a sector like commodities through an ETF? “The core thing is the fact that you get diversification across the companies within that sector of the ASX 200,” says Drew Corbett, head of investment strategy and distribution at BetaShares. “Traditionally a lot of Australian investors would gain their exposure through a smaller group of stocks, usually the bigger companies like BHP and Rio.” An ETF instead gives them exposure to 60 companies in the resources sector, not just the bigger ones. “It allows them instant diversification and lets them participate in the returns of some of the companies benefiting from the mining boom outside the bigger heavyweights.”

Whether or not that’s a good thing depends on how the market is doing, of course, but in 2010 it would have been a great arrangement. According to BetaShare, 21 of the 25 best performing stocks in the ASX 200 in 2010 were resources stocks – and BHP and Rio weren’t among them. “If you’re not invested in an ETF, you’re not getting the benefit of all those stocks.”

It’s particularly relevant because apart from the listed property sector – where Westfield skews the whole industry – there is no other area of investment where one company is so dramatically bigger than its peers. BHP is 41% of the resources sector – much more if you’re only looking at metals and mining – so there is a temptation to think that, once you hold it, you’ve got your resource allocation covered. Smaller resource companies can be unpredictable holdings, but when they thrive, they really thrive.

The Aii range is the most diversified of those on offer today, since it gives three ways of playing the sector. In March, Annmaree Varelas, CEO, called upon investors to look at the energy ETF. “With oil prices on the rise maybe now is the time to consider a higher energy stock exposure for portfolios,” she said, as revolution kicked off across the Middle East and pushed oil prices higher. All those macro themes are still in play two months on and high oil prices do appear to be here to stay. The Aii energy ETF has 22 stocks in it, among them Woodside Petroleum, Origin Energy, Santos and Oil Search, as well as various explorers and service companies.

Aii’s metals and mining ETF is inevitably somewhat lopsided – BHP is more than half the exposure, while Rio and Newcrest take up another 22% – but again the appeal is partly the exposure to those names outside the top 10, those that you probably wouldn’t want to put a lot of your portfolio into in isolation but would appreciate some exposure to.

It’s worth remembering that the commodities boom can also be played just by owning the commodities themselves – and in this respect ETFs have a role to play too.  ETF Securities sells exchange-traded commodities, or ETCs, backed by physical metals. At this stage, though, they exist only over previous metals: gold, silver, platinum, palladium, and a basket of precious metals.

As with everything, there is another side to the coin. Active managers argue that resource companies are exactly the sort of area where blindly buying the market is an error, because there are very good and very average companies within it. The ideal, they would argue, is to own the smaller stars but omit the duds – a fine argument, but much easier said than done.