The next 10 years in ETF growth could be dominated by this asset class

Hey, how you doing? I'm Ali Selby and welcome to the Rules of Investing, a podcast that gets inside the minds of leading investors, economists and industry experts, all brought to you by Livewire Markets. Today, we're talking all things exchange-traded funds, or ETFs. These listed products have exploded in popularity over the last decade, with the market cap of the industry down under increasing by more than 17.5 times in that period.

Today, 2 million Australians use ETFs to invest, with more than 300 products listed on the ASX and CBO exchanges. There doesn't seem to be any sign of that growth slowing either, with ETF net flows outstripping unlisted managed fund flows for the first time ever in 2023, and that's both in the US and Australia. So why are more Australians turning to ETS?

And where are the best opportunities that can help investors make their money work harder for them, particularly at a time when they need it most? To find out, our guest today is Tamara Haven Bier-Statz, who is a director and the ETF and index investment specialist at BlackRock, Rock, the world's biggest asset allocator.

Today, we'll be talking about some of the themes that have her excited over the next five years, as well as the importance of currency when it comes to investing in global ETFs and whether or not you should consider hedging going forward. If you're an Apple podcast or Spotify user, don't forget to subscribe to the podcast so you don't miss an episode. Or if you're a Livewire subscriber, hit the follow button at the bottom of the wire to be notified when new episodes come out. Music.

Us today on the rules of investing tomorrow. Really excited to feature you on the podcast. Thanks, Ali. It's a pleasure to be here. Let's start with the big picture. Cash rate futures are currently pricing in a few rate cuts this year. The market is pricing in a cash rate of 3.86 by March 2025, which I'm sure is welcome news to many investors. What's BlackRock's outlook for the next 12 months? Yeah, look, that's a tricky one.

Obviously, the RBA meets today, later on today at the time of this recording. Actually, we've seen the pricing, the market pricing for cuts actually move out a little bit. And what we're expecting at today's RBA announcement is for the cash rate to remain on hold. That is widely in line with what the market's thinking as well. What we do expect, though, is the RBA to maintain maximum optionality, if you like, in the language and the messaging in terms of what they deliver to the market.

And that's because, of course, inflation is still above target. Yes, we're certainly seeing the data move in the right direction, but I don't think we're necessarily out of the woods yet, given that inflation is still above target levels. So in terms of the local meeting today, no surprises. We think remain on hold. I think looking forward, that's the timing and pace of rate cuts. Potential rate cuts, is where there's some more conjecture in the market.

And I think, you know, obviously there's what is happening in the US and with the Fed's potential move. And our view is that cuts will be coming in the Fed. And so that will have knock-on effects of what the RBA can do. And one of the things that we'll talk about a little bit later is the impact that rate differentials might have on currency as well, which is important for investors, particularly in international exposures. You talked about a kind of uncertain future.

Do you feel that investors can still expect attractive returns using a passive one-and-done approach in this kind of environment, or would you recommend a more active approach to managing opportunity and risk? Yeah, we tend to not differentiate between a passive or an active approach. I think the markets have been obviously very strong, particularly into the last half of last year, really driven by narrow leadership. And we do think that that has room to continue.

That said, we are starting to see, I guess, more breadth come back into the market. And I think one of the big drivers of the performance in developed market equities really was from that tech-focused AI thematic, which has been incredible really, particularly particularly with some individual names, but even when you look at some of those broad indices, such as the S&P 500. The narrow leadership that has driven that outperformance has been tremendous.

Really quite phenomenal. We do think that this market is definitely different to the markets that we've seen in the previous decades though. So we at BlackRock call it the new investing regime. It's not necessarily a regime that's supportive of one and done, set and forget style investing portfolios. And by that, I mean, there is a need to be a little bit more dynamic, have your hands on the steering wheel, be the pilot, not the passenger, as I like to say.

And that is because there are opportunities in different parts of the investable universe, be that geographically, thematically, and also across asset classes as well. I think a fixed income, particularly at the moment. So in summary, I think every decision that an investor has to make, regardless of how they express that view, is an active one.

So we often talk about ETFs, maybe tracking an index. it's still an active decision to invest in that particular asset class or that particular ETF tracking that index. I want to go back to something that you mentioned before, talking about that surge we've seen in the S&P 500, mostly because of AI and stocks like Nvidia, which have just rallied to the moon and still are up there.

What themes do you believe will drive the majority of returns over the next, say, three years? Well, this is a really good point. BlackRock has highlighted five megaforces that we think are quite important for the investors out there, but also for humanity, frankly. I think artificial intelligence is clearly one of them that's driving markets a lot at the moment. But there's also the transition to a lower carbon economy.

And I think that's really no great surprise, but there has obviously been a real trend from governments and pledges have been made. So regardless of of politics, the fact is that there is a transition happening to hopefully a lower carbon economy. And for us, that means there are investing opportunities as a result. Another megaforce is the future of finance.

And we think that particularly after we saw some of the failures in the regional banks in the US at the beginning of last year, as well as some of the happenings in the European banking landscape, I think that role of private credit is another opportunity and just the changing nature of financial institutions is something that we should keep in mind and may provide investing opportunities also. In addition to that, geopolitical fragmentation. Now, this is quite a big one.

And by geopolitical fragmentation, I think we'd characterize this as the world becoming far more complicated geopolitically. Without going into tons of detail, there's clearly sensitivities now that there maybe previously wasn't and where we saw the world becoming a more globalised place. After COVID, we've now seen that reverse somewhat or peaked, maybe not reverse, but I think we've We've reached peak globalisation.

And now countries in particular are thinking about supply chains, security of supply chains. And so we call that theme in general geopolitical fragmentation. The final megaforce that BlackRock has identified is really that changing demographics megaforce. And it's quite obvious in Australia, of course, but it's not just Australia, all over the developed world. There are aging populations. So there is, I guess, a societal impact on that in terms of the participation rate, in terms of employment.

But there's also opportunities in things such as healthcare, certain parts of the property market. So those five megaforces, digital disruption and artificial intelligence, transition to a lower carbon economy, geopolitical fragmentation, the future of finance, and changing demographics. Broadly, what we call the five megaforces. Many of those themes have more of a global tilt.

What role does currency play when it comes to global ETFs? Yeah, I think this is a great point, Ali. Exchange rates, particularly for Australian investors, certainly have a big impact on portfolio returns when you are investing in international exposures. For example, last year, we saw the US dollar largely be a source of strength across most of the year. So the Aussie dollar was quite a bit weaker relative to its long-term averages.

So when you have changes in currency or exchange rates, that is another driver of your portfolio returns in your home currency. So we think it's incredibly important to think about currency risk, which is why certainly at BlackRock, but just more broadly as a general comment, there are a lot of what we call hedged international exposures now available for clients to invest in and for investors to consider should they wish to, I guess, minimise the effect of that exchange rate volatility.

The AUD is currently trading below its long-run average of around 75 cents to the US dollar. Do you feel like the Aussie dollar could pick up later on in the year? I think there's a lot of economists and market watchers paying a really close eye to the currency at the moment, Ali, and that's because as we spoke about the impact of exchange rates, particularly on your international exposures, is really going to have an impact on overall portfolio performance.

Do I think it's going to pick up during the year? I think it's a multifaceted question. So the Aussie, in my experience, trades the way it does for a number of reasons. One is fundamental differences between interest rate differentials in the US versus This is Australia. I think given the expectation of more aggressive easing in the US versus what's currently priced into markets in Australia, could see upward pressure on the

Aussies. So that's one thing. I think the other thing, particularly in these quite volatile markets, is the fact that historically the Aussie dollar has traded as what we call a risk currency. So by risk currency, I mean, when global sentiment is low or something terrible in the world happens, you can often see downward pressure on the Aussie dollar. And I think the other really interesting dynamic that we're seeing at the moment is what's happening with commodity prices.

Now, it's probably not a huge surprise to many of your listeners to hear that Australia is really, in terms of exports anyway, anyway, is really driven by what's happening in our materials sector. And when we look at something like iron ore and the price of iron ore, which is currently around 100 US dollars a ton, we have historically seen Aussie move quite closely in line with the iron ore price. Now, that dynamic seems to have decoupled a bit lately.

And instead, what we're seeing is the Aussie move more in line with copper. Now copper is, you know, from an Australian production perspective, we're not. As much known for our copper production as we are our iron ore production. So it is quite interesting that the Aussie dollar has instead decided to move in lockstep with the copper price.

Well, it had been. That has actually also, we've seen a little bit of divergence very recently where the copper price has started to trend up, but the Aussie hasn't followed.

So whichever way you look at it, whether it's through tracking the copper price or whether it's more a fundamental interest rate differential perspective, or indeed, if it's more a risk sentiment perspective, if you do believe that the, I guess, the global economy is headed for more of that soft landing, I think that there is potential for the Aussie to move a little bit higher, certainly relative to its long-term historical averages, as you mentioned,

you know, 65 or 65 and a half cents where it's currently trading. It does feel as though it's a little underdone. But obviously, do your own research. It is a tricky thing to guess the direction of currencies.

Okay, so with all that in mind, should investors consider hedged versions of their favourite ETF products? Look, absolutely, Ali. I would say they should definitely consider it. And I think it depends on what else is in their portfolio overall as to decide how much or if to invest in a hedged version of their international equity exposure.

I mean, the good news is, given the development in ETF markets, you know, from ourselves as well as others, there are a lot of hedged choices available for investors. And we've actually seen that in some of our flows this year. So I guess one of the benefits of working in the ETF markets is that we do see a lot lot of data. And we have actually seen hedged inflows outpace unhedged inflows.

So still inflows in terms of, I'm thinking about a global equity exposure that we have, where we have an unhedged version and a hedged version. We are definitely seeing a lot more interest, certainly from the flow data anyway, in the hedged version.

China is currently out of favour with investors at at the moment. Is there another global market that you are favouring right now instead? Yeah, there are certainly geographical opportunities. And I think in that general region, Japan is one that the firm is looking at very closely and we're quite positive on Japan at the moment.

Clearly, it's very topical right now because of the BOJ, the upcoming meeting with with the Bank of Japan, where we might finally see a move in their interest rate, their cash rate. So I think there's obviously inflation returning to Japan, which is actually a good thing for that economy. We're also seeing, I guess, a bigger driver, and I think something that we think is really very interesting, is the corporate reform that's happening in that jurisdiction.

So that is really great news for investors who are considering investing into Japanese companies or the Japanese equity market at large. So we're very positive on Japan at the moment, and we think that there are still opportunities. It has obviously had quite a good run already in terms of performance, but we do think that there's potentially more to be seen in that part of the world.

Are there any other geographies that you're interested in right now? Well, look, we're tactically overweight U.S. Equities, and that's really driven by the strength in what we're seeing in artificial intelligence as well. We know that that has also run quite a long way, but in terms of some of the opportunities that are available still in developed markets. So both the U.S. and Japan are developed markets, but we do have a tactical overweight to U.S.

Equities as well. A lot of people have kind of been talking about AI as this amazing opportunity, but there's other people on the other side of that who are calling it a bubble and likening it to the 2000s tech boom and bust. Right. Why do you think that isn't the case? I guess the sheer magnitude of how far some of those single names have run, you know, has, I guess, caused some people to say that kind of thing. We disagree. agree.

We do think that the artificial intelligence, it's not just a passing fad, right? Artificial intelligence has been worked on by scientists and data scientists and computer scientists for decades, actually. It now just feels like the time is ripe and it's actually, we're seeing the effects and the benefits that a technology such as artificial intelligence and large language models now starting to infiltrate, I guess, broader industries, right?

So the productivity gains that are potentially available to companies that can use this type of technology are immense. So from the hardware to those that can use the hardware to those that can extract the productivity gains, that's why we're so positive on this as a megaforce more broadly. Okay. More than 2 million Australians are currently using ETFs to invest today. We also saw ETF flows dethrone managed fund flows in 2023.

Why do you think that is? I think there has just been a bit of a revolution, which I'm obviously really happy to talk about ETFs all day, every day. But there has been a bit of a revolution in terms of the understanding of what an exchange traded fund is. And now that it's become more, I guess, popularised, people talking about ETFs on things like podcasts, for example, the range that's available and the ease of investing into an ETF is really just one of the...

We do think it has actually revolutionized the landscape for investors in terms of getting access. We already spoke about international exposures. Being able to access international exposures by investing in an ETF that's listed on one of the local exchanges here is just a huge difference to what investors might have been used to. So you can now get exposure to some of those names that are doing phenomenally well in the US. you can get exposure to Europe, to parts of Asia.

You can then become far more thematic. So I think the choice of ETFs that are available, the transparency is very important. So by transparency, I mean you are able to see at any given time with an ETF what is actually held in that fund. And maybe I should have started a step further. The fact that ETFs are diversified pools of securities securities is also a benefit in and of itself.

You're taking out that idiosyncratic single security risk that abounds when you invest in a single name and diversifying. So spreading your risk, not having all of your eggs in one basket, as we like to say. And accessible. And by accessible, I guess there's a couple of reasons why they're accessible.

One, they're available to access through your regular brokerage account, but they're also, generally speaking, lower cost in terms of management fees than what you've historically found in a traditional managed fund. And maybe one thing that might be interesting, Ali, is that what we've seen in Australia today is phenomenal growth, but it is actually dwarfed by what we've seen in other developed markets.

So when I think about the US market, where ETFs as a proportion of investable assets under management make up some 12 to 13%, in Australia, we're only at 5%. So 5% of the investable equity universe is invested or the investment expression is made through an ETF. So there's still, I guess, a huge runway in terms of take-up for ETF investors.

When I look at something a little bit more specific, so the fixed income market, fixed income as an asset class has historically been potentially not as well understood as the equity markets, seem to be harder to access. Success, ETFs have changed that completely. So when I think about the penetration rate, if you like, of fixed income ETFs in the Australian market, it's around 2%.

So again, relative to developed markets such as the US and Europe, where that number is much higher, sort of in the high single digits, we do think that there's still a long run way to go in terms of ETF take up. Do you feel like that's where you'll see the lion's share of growth over the coming decade within that fixed income sphere of ETFs?

Yeah, fixed income is something that we're really happy to talk about all day, every day, because it has been a bit of a, as I mentioned before, not as well understood part of the investable markets for a lot of people. And obviously, we've had this major repricing in terms of interest rates, right? We've gone to the best part of zero to something, okay, here in Australia, here in the US.

And so we have seen interest rate rises change, I guess, the investment outlook for fixed income or fixed interest. In fact, some would argue it's a generational opportunity to invest in fixed income at the moment. Now, the fixed income markets are actually quite nuanced. There's different parts of the fixed income market. So there's government bonds, then there's the credit space. So credit is widely, is the term given to debt, which is issued by corporations or companies.

There's again, you know, various geographies, so emerging market debt, for example, and different parts of the credit spectrum. So I think fixed income is a really really great opportunity. And that has really changed, I guess, the risk reward equation that investors now have at their fingertips, right? So you don't necessarily have to go too far down the risk spectrum to get decent yield. And that is because of what's happened with interest rates.

So I think fixed income is really interesting. And we have seen, I guess, a proliferation of fixed income exposures come onto the market in Australia and globally as well. You talked about the proliferation of fixed income ETS.

What else are you seeing as a major innovation within the ETF marketplace right now? Look, I think fixed income is definitely one of the bright lights for us anyway in terms of product innovation and development, as well as the fact that fixed income is, is still underrepresented relative to equity-based exposures. But there are also a lot of exposures that are more specific and more granular in terms of style. So for example, investors might want to consider factor-based strategies.

So factor ETFs are something that have become quite popular in the Australian market as well as globally. So by factor, I mean, quality exposures or value exposures or momentum exposures. So that's certainly an area that we've been focusing on more recently. And we think it's an exciting innovation for the Australian investor community.

As well as that, I think just generally looking at more and more granular slices of markets, markets, whether that's a particular geography, whether it is something like a particular factor, equity style factor, or whether it's a particular part of the fixed income market. In ETFs, what we're seeing is far more granular choices to complement what's already available in the broad market exposures as well. And I think this is all about giving investors choice and allowing them to be

the pilot, not the passenger. ginger. So I think that's a really positive development for investors.

Let's get a little bit more granular now. Where are you seeing the most flows into BlackRock products and where are you seeing the most outflows, maybe since the beginning of the year? Yeah, it's been a really phenomenal start in terms of net flow. So after taking all the ins, all the outs, it really has been a positive start overall in terms of absolute numbers, which I think is just symptomatic of investors wanting to put cash to work. Which is great. So I think where we've seen the most.

Positive inflows are in some of our broad market equity exposures, one of our flagship funds, which tracks the S&P ASX 200 exposure has been incredibly popular in terms of flows this year. We've seen similar inflows into the S&P 500 exposure that we have. have. Infrastructure has also been really strong, which is, I guess, aligned with our view on some of the opportunities, particularly as a result of the transition to a lower carbon economy.

Infrastructure is obviously very important when you think about that particular megaforce. So infrastructure has had a lot of inflows. The other interesting thing that I'd call out is we've had, I think we spoke about currency a fair bit earlier, Ali, and I think we have versions of hedged exposures, which we are seeing investors start to take, I guess, advantage of having that choice.

And we are seeing a lot more inflows into our hedged version of a global equity exposure than its corresponding unhedged version, which certainly talks to, I think, investors being a little bit more nimble and a little bit more deliberate on looking at that currency exposure that they have with those international equities. On the outflow side, it's been a bit mixed. We've seen certain parts of Asia have particular outflows. So Japan and South Korea, slightly down.

And interestingly, that could potentially be as a result of profit taking. Interestingly, we've seen inflows or net inflows into our China exposure, which is obviously quite interesting. It certainly has been a market that has been challenged of late. We love to pose common questions to our guests before we wrap up this podcast.

This is a bit of fun. It's a bit of a thought experiment. In your view, what's the one thing investors are getting wrong about today's markets? That is a tricky question. I think that, you know, they're tricky. They're definitely trickier markets, that's for sure. So I think the need to be a little bit more nimble is really important for investors.

And by that, I mean, we certainly advocate for long-term investing and, you know, we We certainly want savers to become investors, but there is definitely a need to be more nimble and dynamic. So I think keeping a closer eye on your portfolios in this particular market is probably prudent. And I would suggest to all of the listeners that they do that. Okay. Last question for today.

Which investment theme or trend do you believe will drive the lion's share of returns or the lion's share of opportunities over the next five years? If you could only choose one. Well, I really like the artificial intelligence theme. I think that's phenomenal. I just have to look at how it's changing my own day-to-day life. Whether or not you work in finance, there is so much happening in that artificial intelligence space and digitalization in general.

I think it's changing the way that we work, the way we communicate, for better or for worse, but also the investing opportunities as well. So I think it's incredibly exciting. writing. It's certainly a thing that we really like at BlackRock and it's certainly following personally, personally as well. Okay. Well, thank you so much for your today, Tamara. It was a pleasure to speak with you today. Thanks for having me, Ali. Yeah, really nice to be here.

Thank you so much for listening to that podcast. I hope you enjoyed that discussion as much as I did.

If you're enjoying The Rules of Investing, we'd love you to subscribe to the podcast so you can stay up to date with future episodes. Thank you again for taking the time. Music.