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This is how ETFs are rewiring the ASX & could make or break your returns

Housing Bubble

The Pro Medicus Limited (ASX: PME) share price hit a record high of $30.28 this morning despite it being labelled a ‘speculative bubble’ by high profile funds management team Forager Funds alongside 1o other companies with market values greater than $500 million, but revenue less than $50 million.

Other stocks labelled a bubble include Audinate Ltd (ASX: AD8)Polynovo Ltd (ASX: PNV) and iSignthis Ltd (ASX: ISX). You can read the Forager report and further explanations here.

On June 24 2019 Pro Medicus joined the S&P/ ASX200 Index (ASX: XJO) of Australia’s top 200 companies, which is the most widely tracked index by passive investment funds that investors can buy shares in via exchange traded funds (ETFs).

According to a press release from exchange traded fund merchant Betashares I received recently, Australian ETFs now represent $50 billion of investors’ money, with the total climbing by 25%, or $10 billion, over just the first half of 2019, although not all the ETF money is flowing into Australian equities. 

Still these are some exceptional growth stats and it’s worth noting ETFs now control more than the total market value of Telstra Corporation Ltd (ASX: TLS), or around 17x the total market value of an S&P/ ASX200 member like Pro Medicus.

If we consider how small the Australian share market is outside the four big banks and some miners, we can see how ETFs that are mandated to buy equivalent weightings of any member of the S&P/ ASX200 can unduly influence share prices.

Especially in stocks with relatively illiquid free floats like Pro Medicus.

For reference since it was publicly confirmed on June 14 2019 that Pro Medicus would be added to the S&P/ ASX200 the stock has climbed from $23.19 to $30.28 in around one month, despite the company releasing no news.

This suggests that index tracking may be distorting valuations, with some traders, punters, or computers, probably trying to buy companies before they’re added to the index in anticipation of being able to make a quick profit by selling their shares on later probably to ETFs. 

The worry for active ‘value’ managers struggling to reconcile these wild valuation moves is that Vanguard’s flagship Australian equity ETF only charges fees of 10 basis points, which is typically less than 1/10th of what an active manager might charge anywhere between 0.8% to 1.5%, or more for exotic strategies. And that’s before performance fees that limit your upside.

The low fees that are attracting the flood of money into ETFs are boosting less liquid stocks like Pro Medicus and other new members of the S&P/ ASX200 that Mr Johnson labels a bubble such as Clinuvel Pharmaceuticals Ltd (ASX: CUV).

This could also become a multiplier effect as the more ‘value managers’ ignore these stocks and underperform the index the more money could flow into ETFs to chase them. Talk about an unvirtuous circle. 

The kicker is that Betashares is forecasting ETF FUM to grow to $60 billion by just the end of 2019. 

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Tom Richardson owns shares of Pro Medicus Ltd.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of AUDINATEGL FPO. The Motley Fool Australia's parent company Motley Fool Holdings Inc. recommends Pro Medicus Ltd. The Motley Fool Australia owns shares of and has recommended Pro Medicus Ltd. and Telstra Limited. The Motley Fool Australia has recommended AUDINATEGL FPO. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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