Under the Hood | Help me narrow down my ETF theme choices!

Bryce: [00:00:31] Welcome to Get Started Investing feed podcast, where we attempt to answer the most common money and investing questions that come in from our community to help us all become better investors. If you are joining us for the first time, a massive welcome. We strongly recommend that you scroll up and start at episode one and a reminder that while we are licensed when not aware of your personal circumstances. All information on this show is for education and entertainment purposes only. With that said, though, my name is Bryce and as always, I'm joined by my equity buddy, Ren. How are you? 

Alec: [00:00:59] I'm very good, Bryce. Excited. We have reached the second half of this ten part Under the Hood series. Yes, we've answered some of the big questions when it comes to ETFs, but I think this question for me is one that really stands out as an important one. There is so many ETFs now, more than 300 listed in Australia, probably heaps more on the way. It can be hard to know when there's multiple ETFs tracking the same theme or the same index. Are they actually the same or how are they different? And that's what we're really going to be covering today. How do we know and what are the steps we can take to find out? 

Bryce: [00:01:35] Yeah, we're going to be unpacking and asking the question, you know, what are the different ways to track an asset class? And we're going to be using that global physical gold ticket gold as a case study. But it is our pleasure to welcome to the Equity Mates studio, another guest from Global X, David Tuckwell. David, welcome. 

David: [00:01:54] Thanks for having me, guys. 

Bryce: [00:01:55] So David is an investment specialist at Global X and a massive thanks to Global X ETFs for supporting this series, which is such an important series. One we've wanted to get off the ground for a while. Global X are a leading player in the ETF industry and really pride themselves on the industry leading research team that they have and incredible global access trusted reputation around the world with millions of clients and over 30 targeted products. So make sure you check out globalxetfs.com.au as we progress through this series. But to kick things off, we have a question from our community. 

EM Community: [00:02:28] Hey Equity Mates really want to buy a couple of different thematic ETFs, but there's more than a few options for me to choose from. I mean, how do I even start narrowing my choices down? Thanks, guys. 

Alec: [00:02:38] So, David, I think the starting point when it comes to this topic is that basically every asset, every market, every theme these days is seems to be able to be tracked through an ETF. Everything is investable now with ETFs. But the challenge is how are we investing in that and what's the methodology and what's the make up? And we chose the physical gold ETF to talk about it today because we think it's a really good gold is a really good case study for this. And there are a couple of different ways you can track the same metal being gold and you'll hear the terms physical and synthetic. So can you give us a bit of an overview on what we're talking about here? 

David: [00:03:20] Absolutely. And this isn't just the case in Australia. It's a case right around the world. There's two main ways really you can access the assets that an ETF tracks, be it gold bid, NASDAQ 100 shares bit anything else. The first way called physical, as you rightly characterise it, is to just go out and buy the shares or buy the bars of gold. It's pretty simple, pretty straightforward. It's what most people expect and they understand from an ETF. So a physical gold ETF such as ours would do the simple and obvious thing and just buy bars of gold, stick them in a bank vault. And when you buy the ETF, you by extension buy the bars of gold. Simple, easy, straightforward. 

Bryce: [00:04:00] Which bank is about a bar of gold?

David: [00:04:02] Jp morgan. 

Alec: [00:04:04] Have you ever gone in to check them out? Yeah.

David: [00:04:06] Interesting story there, actually. So we don't actually know the location of our bank JP Morgan.

Bryce: [00:04:12] Yeah, if that's encouraging, right?

David: [00:04:16] Yeah. It's not. It's not that we can't find it on a map at JP Morgan and most, you know, most big, most of the big, big banks that hold lots of gold just don't tell you where it is. Yeah, that's exactly right. So if you do want to go visit it and audit the bars of gold and check that they're real, you are. You get blindfolded, put in the back of a car. Deadly serious. Serious, serious. I'm deadly serious. 

Bryce: [00:04:40] You don't even know if it's in Australia or like. 

David: [00:04:42] We know that it's in London somewhere. We believe it's somewhere in central London, not far from the Bank of England. But that's the process. If you do, when you get blindfolded, you get blindfolded. That's a 100% 

Bryce: [00:04:53] On the plane over?

David: [00:04:55] Not on the plane. You go to JPMorgan's offices, you check in. Then a certain specialist, you know, arranges for you to be blindfolded and put in the car. And it sounds fake. 

Alec: [00:05:07] Does I really want to do this on my bucket list now? 

David: [00:05:12] But no, but that's real. And then you get there and it's amazing how quickly you can walk past $10 billion worth of gold because every buyer of gold is just so expensive, almost $1,000,000 age. You take ten steps and you just walk past. Wow, billions of dollars. Wow. Yeah, that's yeah, we don't know the location of the vault, but yeah, somewhere in central London. 

Alec: [00:05:30] That's wild. So that's physical gold, as he said, physical gold. That's what people would expect. If I buy a gold ETF. There is gold. 

David: [00:05:38] That's exactly right. Yeah. 

Alec: [00:05:39] And then we go to synthetic. 

David: [00:05:41] Yeah. So Synthetic essentially uses some kind of derivative to give you access to gold or the Nasdaq 100 or whatever else it is. And that derivative could be a swap, it could be futures, it could be some kind of call option. But at the end of the day, if you own a synthetic ETF, you don't, legally speaking, own the asset as such, you own the credit risk or the liability of some financial institution. So to give you an idea, would you like some an example with, so we provide a Nasdaq 100 hedge fund ourselves that is synthetic and it uses NASDAQ 100 futures. So for people that buy that and they wouldn't, in our case, own Nasdaq 100 shares, they would own NASDAQ 100 futures, which is, you know, separate from, say, other parties out there that might provide a physical NASDAQ 100 ETF and they would own the shares in the Nasdaq 100. So that's a difference. 

Bryce: [00:06:34] So that's the difference. And there was a bit of jargon in there. So perhaps if you can explain why, what are the pros and cons of each? 

David: [00:06:44] No, that's a that's a very good question. The physical ETFs. So physical gold owning the Nasdaq, 100 shares or whatever else have the obvious advantages of safety and comfort and all the rest of it. You know, if you for most people, the obvious, obviously safe thing is to own the bars of gold, to own the shares in the Nasdaq 100 or whatever else. And there's a certain peace of mind there. And for that reason, over 95% of ETFs in Australia and around the world are physical. That being said, synthetic ETFs can have advantages, especially around performance and in some cases, especially in Europe, around tax efficiencies. Be mindful about getting into that too far into the jargon. But because of the way that synthetic ETFs work, you can sort of push taxable events outside of the fund and you can sort of avoid transaction costs in some instances if you use derivatives. So to give you an example, again, with the Nasdaq 100 futures, you don't pay a dividend tax on NASDAQ 100 shares if you invest in the futures, whereas if you buy the shares, for instance, via Betashares ETF, you have to pay taxes on the dividends. So that yeah, so you dodge tax if you go the synthetic route. 

Bryce: [00:08:03] So those are the two sort of broad ways that ETFs are constructed to give you exposure to an asset class. You've got actually buying the physical asset class and getting into an ETF that way. Or companies go out and create a synthetic ETF using derivatives or other financial products to give you exposure really to the price movement. Not to the actual asset. That then leads us to how do I know if the ETF I'm buying is physical or is it a synthetic? What do I need to do to find out about my ETF? 

David: [00:08:41] That's another really good question. The main benefit I think, of ETFs over other kinds of fund is they're fully transparent. So you can go onto the website of any ETF in Australia and look at what's inside of it. And so one of the things we learnt from the 2008 financial crisis is that transparency is very important for maintaining safe markets because of the 2008 financial crisis, whereas people didn't know where the risk was, people were trading, investment bankers were trading these multibillion dollar debt instruments and no one knew what was inside of them. ETFs don't have that problem. It's just you go on to the website and it'll tell you exactly what's in there. So if you are looking to find a synthetic ETF, you'll see that it gets most of its exposure and it'll just be there on the website from something like a futures contract, something like a swap, something I call ups and that'll be public and published. Other things you can do is you can just call up the ETF provider and ask ETF

Alec: [00:09:35] Does anyone call these days?

David: [00:09:36] Yeah. Or we get calls all the time. All the time. All the time. And people and staff at the providers themselves aren't, you know, legal certain legal requirements to tell the truth about this. So it's not something we can lie about. You never lie about it. But it's also if you really wanted to, you could read the piece and that would probably be the most advisable approach to take. Just read the PDS.

Alec: [00:09:59] The one thing we quite like about the ETF we're talking about today, the Global X Physical Gold ETF is that the name does a lot of the heavy lifting, physical gold Yeah unlawful. And you know if you look at your sin some of your synthetic products you know you mentioned the Nasdaq. It has covered coal in the title. You know That it's a synthetic product because that the instruments it's investing in are in the title. Unfortunately, not all ETF providers are so descriptive. They don't say physical gold. So what is becoming a recurring theme in these subjects is the most valuable source of information for any ETF is the ETF provider's website. For this one in particular, for this physical gold ETF globalxetfs.com.au. We also do love that global X put physical gold in the desk of this

Bryce: [00:10:55] What's in the name. 

Alec: [00:10:56] Yeah yeah yeah. And as we always like to start we look at its purpose what it's trying to do the index of attracts, how it's trying to do that and the fees it charges, how much it costs to do that. So let's start with the purpose physical gold ETF from global X. What's it trying to do? [

David: [00:11:13] So it just aims to do a very straightforward thing and give investors a way to invest in bars of gold. Historically, before gold ETFs came along, you sort of had two ways of getting access to gold. The first thing you could do is you go to some kind of bullion bank or bullion dealer and buy a bar of gold yourself. The problem with doing that is you had to arrange for security yourself, and that could be a very, very, very dangerous game. So Kerry Packer, at the time, Australia's richest man, had $5 million of gold bars, I believe, stolen out of his office. 

Alec: [00:11:44] No way.

David: [00:11:45] That's serious. Yeah. Even so, even the mighty Packer couldn't arrange security for it. And then once you wanted to sell your bars of gold, you'd have to find someone to sell it to. So you'd have to then find a seller. The other approach you could take is to buy shares in gold mining companies, miners of all kind. Whether it's BHP or Fortescue. Their share prices tend to correlate to a large extent with the value of the commodities they mine and gold Mine is no exception here. Their share prices correlate with the gold price. But the problem there, of course, is they don't just follow the gold price. You've also got to invest in a management team and maybe that management team is highly competent, but maybe they're not. You're also buying a company's balance sheet, and maybe it's a good balance sheet, maybe it's not. So other variables come into play other than just the gold price. What gold ETFs did and do is they sort of put those two things together. They give you a way to buy bars of gold, but on exchange, in the same way that you buy shares in a gold mining company. So you don't have to worry about security, but you also don't have to worry about your investment. Not correlating with the gold price.

Bryce: [00:12:48] Gives you the liquidity as well. Don't need to find someone to sell it to. 

David: [00:12:50] Absolutely. 

Bryce: [00:12:51] As with five bars of $5 billion in physical gold bars. Now talk about the index here because it's slightly different to a lot of the A lot of the ETFs that we've used as examples in previous episodes. Does it track any index? 

David: [00:13:09] Yes, it does. So it tracks the spot price of gold. And the best index for that would be the BMI closing price. So the album is essentially the gold exchange. So most gold is traded on an exchange in London called the BMA. It's really one of those exchanges that's own only really for investment bank specialist traders, gold refiners and people within the gold industry. But that's where 70% of global gold change is on this highly specialist exchange in London. 

Alec: [00:13:36] Right. And I'm getting the sense that London is the home of gold. 

David: [00:13:40] Yeah. It's the legacy. The gold standard from the 19th century. Yeah. Yeah, that's right. 

Bryce: [00:13:45] And so the price is obviously set through the exchange. That's right. And it takes the closing price each day. 

David: [00:13:52] That's exactly Right. 

Alec: [00:13:53] Yep. And I assume converts back to Aussie dollar. 

David: [00:13:56] That's exactly right. You guys know more than me. 

Bryce: [00:14:00] Yeah, we'll finish it there.

Alec: [00:14:01] Yeah, the Equity Mates gold coming soon. And we always look at phase, which again, you can see on the ETF provider's website for this ATF, it's 0.4%. 

David: [00:14:12] That's right. So eight gold ETFs. I don't think you'll ever see a gold ETF offering the same kind of fee that you see on some of these popular share market ETFs. So, for instance, you've got ETFs in Australia that invest in 200 or 300 Australian stocks charging fees as low as four or five basis points. You can't really do that for gold simply because the supply chain costs are higher. 

Alec: [00:14:36] So you've got to pay Jp Morgan. Yeah. 

David: [00:14:38] Yeah, yeah. Security. 

Alec: [00:14:40] Yeah, yeah. 

David: [00:14:42] No, no, no, no. So you've got to sort of sort out Cassidy, you've got to sort out security for it. And that immediately raises fees way above anything that we can provide for share market ETFs. 

Bryce: [00:14:56] But it's a small fraction of the fee you'd be paying if you needed your own security. 

David: [00:15:00] That's exactly. 

Bryce: [00:15:01] Yes. 

David: [00:15:02] That's exactly right. That's exactly right. Yeah. 

Bryce: [00:15:05] So, David, do you want to just talk us through the returns for the ETF? 

David: [00:15:09] Sure. So I think the one investors should be most interested in is what the longer term returns look like on gold and Aussie dollars. And so over the past 20 years since we launched our gold ETF, the price has gone up by about 9% a year. Putting that in perspective, the ASX 200 total return. So after including after. Including for the effects of dividends, has gone up about 9.2%, so gold in Aussie dollars over the past 20 years at least has offered pretty similar returns to the ASX 200. Of course, the past is no guide to the future. You know, you insert usual disclaimers here, but investors haven't been hard done by at all investing in gold over the longer term. 

Alec: [00:15:51] So where we normally turn here for these under the hood episodes is we look at top holdings, the geography. Sectors. That's going to be a pretty quick segment here. 

David: [00:16:02] It's going to be a very quick segment. So bars of gold, that's it. 

Bryce: [00:16:06] 100% gold. 

David: [00:16:08] 100% gold and nothing else. 

Alec: [00:16:09] Yeah, I mean, that would be surprising, though. 

Bryce: [00:16:11] Sometimes you say like 99% and then 1% cash. 

Alec: [00:16:15] Or maybe a bit of silver today. 

David: [00:16:21] Know, there's hundreds and hundreds and hundreds of gold bars existing. Yeah.

Alec: [00:16:25] So I guess one question that people have when we talk about a gold ETF because, you know, an ETF is different to some other funds out there where there's a set number of units and you buy and sell those set number of units. Yeah, with ETFs, you as more people put money in, you create more units and then you track the actual price, which then leads to the question what happens if people sell a gold ETF, do you then actually sell the physical gold? 

David: [00:16:56] Okay. Yes. 

Alec: [00:16:57] How does that work? 

David: [00:16:58] Yeah. So I think you've touched on a crucial point here about how ETFs are different to perhaps other kinds of fund ETF. They're open ended. So for those who've done microeconomics or just economics one on one, if you've got the supply of something fixed as the supply of certain other kinds of fund is fixed, like listed investment trusts or listed investment companies, for instance, and demand goes up or down the price of that stock. Yeah, the price of that listed investment trust or something else, they can't adjust the supply to match the demand. ETFs, by contrast, are open ended, so we can always adjust supply to match demand to ensure there's no pricing dislocations. So yes, you're exactly right. When demand goes up and more and more people want to buy gold ETFs, we have to go out and buy more gold to make sure that our ETFs are fully backed and the other. And it works in reverse. When people don't want the ETF anymore more, you go out and sell the gold. 

Alec: [00:17:52] And for context, yeah, there's about $2.7 billion in assets. Yes, that's right at the moment. So there's $2.7 billion worth of gold that close owns in a JPMorgan Morgan vault somewhere. Yes, that's right. Don't try and steal it. 

Bryce: [00:18:05] Do you have a photo? 

David: [00:18:06] A photo? I don't I unfortunately did but you'd be surprised how small it is guys. It's a yeah it's. 

Alec: [00:18:15] Like a bolt in Harry Potter. 

Bryce: [00:18:17] I used. To work in a bank during uni, and it's the same thing like you imagine, like hundreds of thousands, if not millions of dollars. To me, this overwhelming amount of cash that's like a centimetre tall. 

Alec: [00:18:35] So. So I guess, like, let's say you've got $2.7 billion worth of gold vault and some big fish. Priceless comes in and so yeah, yeah. $200 million worth. Yeah, Yeah. Like, are you sending that out of the vault somewhere or are they moving it from one side of the vault to the other side. 

David: [00:18:52] Actually, yeah. So how does the actual movement of gold work down? That's again, a good question. So the way it would work is pretty much exactly like you described it. JPMorgan. We have our own special pile of bars in there in the underground vault. And once Bryce or whoever, whoever else dumps their holdings, yeah, it gets I don't think they pick it up because bars of gold are very, very heavy. It's a very, very dense metal. I think they use a forklift most of the time and actually pick up the crates and just go somewhere else to sell. Pile. Yeah, Yeah. That's basically what happens. Yeah.

Bryce: [00:19:27] Wow. It's so old School. 

David: [00:19:30] Yeah, very old school. Yeah. 

Bryce: [00:19:32] I guess there's no alternative. 

Alec: [00:19:34] Non synthetics. So then you've got all the problems with synthetic. Yeah.

Bryce: [00:19:39] So that is fascinating. Yeah. So David, to close out the episode, we've been discussing how these ETFs kind of fit into a portfolio and gold is slightly different to a lot of the assets that we've been talking about, primarily equities. So how do you think about gold and its position in a retail investors portfolio? 

David: [00:20:01] Yeah, so gold is highly unusual in that you don't want it to perform well. So the times that gold does best tends to be times like today where you've got war ravaging Eastern Europe, you've got inflation out of control, you've got banks collapsing. When all these mean and nasty things happen, the gold price tends to do very well. We saw the same thing during 911. We saw the same thing during the dot com bust. We saw the same thing during 2008. So gold is an unusual addition to port. Folios in that you don't want it to do well. You want everything else to do well. You want your shares, you want your bonds, you want your properties to do well, because when they do well, chances are the world is going nicely. Australia's economy is growing and your wealth is growing with it. So for that reason, the way we tend to think of gold is quite like an insurance policy. When you buy insurance on your house or insurance on your car or whatever else, you don't want your house to burn down. You don't want your car to get jacked. You want your car. You want your house to carry on going smoothly, as they always do. But should something happen, should something happen to your house? Your insurance policy will perform. It will pay out. We think of gold in the same way it's in there as is, in effect, a kind of portfolio insurance and ultimately as a diversifier. So should those bad times come along like the times we're in today? Gold will do some lifting for you, but yeah, gold is not added to portfolios in the way that shares or bonds are. They obviously give you the engines of growth long term for your wealth and for your portfolio. Gold doesn't play that same role. Very much a diversifier, very much a form of insurance. 

Bryce: [00:21:32] Despite generating 9% for the last ten years. 

David: [00:21:34] Yeah, well, yeah, well, it's obviously we've had a bit of a rough bit of a rough 20 years, especially because over the past and for the financial crisis we've had Covid now we've had today. So we've had a bit of a rough spell. 

Bryce: [00:21:46] And for context at the time of recording, the gold price is at, if not just below all time high. 

David: [00:21:51] That's, that's right. Yeah.

Bryce: [00:21:52] It is certainly playing out as expected. Well David, thank you so much for coming on and I really hope is helping us to understand firstly the difference between the physical and the synthetic side of things. Yeah, and this doesn't just apply to gold, this applies to multiple different assets and even, you know, equities, as you mentioned, there are products that are synthetic when you're getting exposure to the equity markets as well. So keep an eye out for them. Make sure you go under the hood and understand what you're buying. But a big thank you to Global X as well for supporting the Under the Hood series. They're a leading player in the ETF industry with over 30 targeted products. If you'd like to find more about their range of products, head to globalxetfs.com.au. There's plenty of information and also industry leading research. They have an amazing research and analyst team from around the globe. So as I said, a huge thank you for the support. And David, it's been an absolute pleasure as always. 

David: [00:22:51] Thanks for having me. 

Bryce: [00:22:51] Stick around. We'll be back with episode seven next week with Blair looking at the topic of ETF overlap, Ren, something that is often a question asked in the Equity Mates community. 

Alec: [00:23:02] Yeah, big question in the Facebook group. So excited to get into that one next week.