Australian investors went on an ETFs splurge in 2023, underscoring the growing popularity of exchange traded products.

Record investor inflows, coupled with strong market gains, saw the size of Australia’s exchange traded funds (ETFs) sector surge 33% last year to a record $173 billion.

Australian Securities Exchange (ASX) data shows the combination of ETF inflows and broad market gains added more than $42 billion to Australian-listed ETFs over the course of 2023.

At the start of 2023 total assets under management across Australia’s ETFs sector stood at around $130.4 billion following the negative returns across global equity and bond markets in 2022.

But last year marked a major turnaround year, with rising interest rate returns spurring record inflows into fixed income (bond) ETFs and buoyant equity markets also generating solid demand for index ETFs tracking share markets.

It was fixed income ETFs that invest in bond issues that largely stole the show in 2023, with Australian bond ETFs attracting inflows of more than $3.8 billion and international bond ETFs listed on the ASX around a further $1.5 billion.

The combined $5.4 billion of inflows into bond ETFs just exceeded the $5.3 billion of inflows into Australian equity ETFs.

Demand for bond ETFs to continue

Fixed income is set to remain a key driver for ETFs over the coming years as investors move to add bond products into their portfolios for greater diversification.

Although central banks are expected to reduce interest rates in the second half of 2024, rates are likely to stay relatively higher for longer.

“While higher interest rates for longer might be painful for borrowers, they’re actually a good thing for investors over the long run, particularly for bond investors,” says Adam DeSanctis, Vanguard’s Head of ETF Capital Markets, Asia-Pacific.

“We therefore anticipate bond ETFs to remain popular with Australian investors in the coming year, particularly as domestic bond return expectations have substantially increased since 2022 from 1.3-2.3% to 4.3-5.3% per annum over the next 10 years.

“Hopefully stabilising interest rates this year will also improve investor sentiment and we’re confident growth in the Australian ETF industry will continue”.

Home bias still on display

Broad index ETFs that invest in the largest ASX-listed companies attracted the biggest share of equity inflows in 2023 despite the Australian share market recording a substantially lower return than most international share markets.

The Australian share market, measured by the S&P/ASX 300 Index, recorded a gain of 7.5% over 2023 compared with a gain of almost 24% by the United States share market, measured by S&P 500 Index, and a gain of close to 21.5% by the MSCI World Index.

Despite the stronger gains on offshore markets, ASX-listed ETFs that invest in international markets attracted lower net inflows than Australian equity ETFs.

“It’s clear Aussie investors still favour Aussie equities, perhaps in part due to the familiarity of domestic companies or the view that offshore investments might be riskier,” says Mr DeSanctis.

“This kind of home bias however can be costly, particularly as 2023 saw very strong returns from global equities.

“Investors who weren’t invested or had cashed out in 2022 when global equity returns fell therefore missed out on this extraordinary rebound opportunity.

“A well-diversified portfolio should include both domestic and international investments as these different asset classes will respond differently to the same market forces. This is essential to managing investment risks and portfolio volatility.”

How to get the most out of ETFs…

ETFs have become a hugely popular investment product around the world because they are relatively low cost and highly accessible to everyday investors.

For many new investors, or those who don’t have the time or resources to construct a portfolio using individual investments, ETFs can serve as the primary investment vehicle.