Are Index ETFs worthwhile or a waste of time?

Right now there is a lot of talk that the market is heading for an index squeeze, which has some investors worried about another global financial crisis (GFC) style event occurring. So what is an index squeeze and is index investing a smart way to invest?

As many of you would know, managed funds and Exchange Traded Funds (ETFs) track their performance against an index. So, index squeezing refers to the liquidity of these investments and whether you are able to freely exit if the market were to fall heavily.

You may remember just prior to the GFC investors were swarming into managed funds in record numbers only to get caught trying to exit when the market fell with many funds freezing withdrawals. As a consequence of the negativity surrounding managed funds, the industry decided to console investors by introducing ETFs, which are essentially the same investment but investors can now freely buy and sell them on the exchange or can they?

In my book, this is where the concept of index squeezing needs to be investigated. If the market does start to fall heavily, then the expectation is that investors will start to sell. But if too many decide to sell and there are not enough buyers, then a squeeze will occur and prices will free fall, as investors drop their asking price just so they can exit quickly. Alternatively, the industry will, once again, freeze withdrawals causing significant distress for investors.

As many of you know, I am not a big advocate of Index ETFs for a number of reasons but the biggest reason is because they fail to provide investors with good returns with many struggling to match the return of the index they are supposed to track.

So why is this?

Because someone needs to manage the fund, therefore, investors pay management fees, which come out of the growth of the fund. Of the top six performing index EFTs, I could not find one that has beaten the growth of the All Ordinaries Index. While the All Ordinaries has risen around 21.5 per cent this calendar year, the closest ETF to this return is BetaShares Australia 200, which is just over 21 per cent.

So rather than invest in an index ETF, you could have simply purchased the top 20 shares on the Australian market from the start of this calendar year and achieved a return of around 22 per cent including dividends. And here is the real kicker, all of the stocks in the top 20 are highly liquid, which means you can easily sell at any time including during a GFC style event.

So what were the best and worst performing sectors in the Australian market this week?

The big mover this week was the Communication Services sector, up over 6 per cent on the back of a strong rise from Telstra and TPG. Energy and Healthcare were also top performers up over 3 per cent for the week. Two of last week’s best performers, Consumer Discretionary and Consumer Staples, were in the bottom three sectors this week along with Financials, although they were all in positive territory.

The best performing stock in the ASX top 100 this week is Caltex, which is up over 23 per cent on news of a takeover bid from Canadian based Alimentation Couche-Tard. If you do not already own this stock, you have missed the boat. Other top performers were Adelaide Brighton and Telstra, both up over 8 per cent for the week so far.

Bank of Queensland is the worst performer down over 7 per cent, while Alumina, Bendigo Bank and Incitec Pivot are all down around 2.5 per cent.

So what can we expect on the Australian market moving forward?

Last week I thought the market was leaning more towards being bullish although I was still prepared for it to fall given that it showed weakness during the week. But as I mentioned in my previous report, a week can be a long time in the market and right now I believe we can safely say that the market is officially bullish after the strong rise this week.

The All Ordinaries Index has risen to close higher for five consecutive days and in doing so has broken through its previous all-time high of 6,958 point that occurred on 30 July. While we can expect to see the market pull back for a couple of days over the coming week, I am now confident that it will continue to rise until at least February or March before falling into the next low with my target for this rise to between 7,200 and 7,600 points.

Dale Gillham is Chief Analyst at Wealth Within and international bestselling author of How to Beat the Managed Funds by 20%. He is also the author of Accelerate Your Wealth—It’s Your Money, Your Choice, which is available in bookstores and online at www.wealthwithin.com.au