Unstoppable forces disrupting the finance industry
New low-cost business models are disrupting the traditional high profit margin finance industry.
- Before companies existed, only royalty or wealthy trading families could invest.
- In Australia, Self Managed Super Funds (SMSF) have enjoyed spectacular growth.
- New low-cost business models are suddenly disrupting the traditional, lazy high profit margin finance industry.
If you look back in financial history there are surprisingly few innovations that can truly claim to have reshaped retail investing landscape for the better. I’d highlight companies, indexes, managed funds, index funds and more recently Exchange-Traded Funds (ETFs) and DIY super.
Before companies existed, only royalty or wealthy trading families could invest.
The first company to issue stock, the Dutch East India Company, was formed in 1602 and the world’s first stock exchange was opened in Amsterdam soon after. The Dutch exported these concepts to their fledgling colony, New Amsterdam, which was later renamed New York by the British, where the concepts were developed.
Before we had market indexes (such as the ASX 200 in Australia or the S&P/NZX 50 in New Zealand), no one had any idea how the market performed on any particular day.
In the late 19th century, two reporters from New York, Charles Dow and Edward Jones, created the first market index to measure stock price movements, which they published in a small newsletter with a circulation of several thousand. They named it the Dow Jones Index and their small newsletter eventually become the Wall Street Journal.
Before managed funds, professional investment managers paid for their expertise didn’t exist.
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In the early 20th century a group of Boston academics pooled their knowledge and wealth to create the world’s first actively managed fund, and in 1975 Jack Bogle put his theory about passive investing into practice and launched the world’s first index fund, the Vanguard 500.
The first ETF was born in 1989 in Canada and was known as the Toronto Index Participation Fund (or TIP 35). A year later State Street created the first US ETF.
In 1999 in Australia, Self Managed Super Funds (SMSF) evolved out of the old excluded funds (funds with fewer than five members). Their growth has been spectacular with compound annual growth rate (CAGR) of 15.5% of assets since 2004 to A$675b in March 2017. Just under 1.1 million SMSF members now control 30% of the Australia’s entire A$2.26 trillion superannuation pool.
At the time, each of these financial innovations challenged the prevailing school of thought but, once introduced, quickly developed from heresy to accepted investing dogma.
So over the past decade in finance there have been two unstoppable forces in finance – passive (or index) investing and DIY super.
In Australia this has taken the form of ETF investing and SMSFs. New Zealand has also experienced rapid growth in ETFs but the growth in voluntary, work-based savings initiative KiwiSaver accounts has been less spectacular.
"Over the past decade in finance there have been two unstoppable forces in finance – passive (or index) investing and DIY super."
In the wake of the Global Financial Crisis, consumers are voting with their feet as they increasingly avoid expensive products sold by financial institutions.
Today ETFs and DIY super bring all of these concepts together and leverage the very best bits of each innovation. They are refreshingly cheap and simple way to invest, and their success is threatening the traditional funds management and stockbroking industries.
In Australia, ETFs were introduced by State Street in 2001: one based on the top 200 companies, the SPDR S&P/ASX 200 Fund (STW.ASX), and one based on the large caps, the SPDR S&P/ASX 50 Fund (SFY.ASX).
In New Zealand the NZ Top 10 Fund was launched in 1996 by Smartshares (although growth was hampered by relatively high fees) and Vanguard entered the market in 2015 with a suite of international ETFs.
Since their introduction, they have grown spectacularly at an estimated 30% CAGR to A$28.3b invested across 204 products (source: Betashares).
In Australia, SMSFs have been keen, early adopters of ETFs: 30–40% of all investors in Australian ETFs are SMSFs. SMSF investors have flocked to ETFs due to their low costs, instant diversification, transparency and liquidity.
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SMSF investors who may previously have owned a convoluted portfolio of 25 or more securities appreciate the significant reduction in complexity and paperwork an ETF-based portfolio provides.
SMSF investors with managed funds and expensive platforms now enjoy much reduced ongoing fees via their ETF portfolio.
In New Zealand the growth in KiwiSavers has not been as pronounced but they are starting to increase their exposure to low cost ETF investing, especially following Vanguard’s entry into the New Zealand market.
I believe the combination of rapid growth of passive investing/ ETFs and the rise of DIY super is an Uber or Amazon moment in the finance industry. Together, these two completely new, low-cost business models are suddenly disrupting the traditional, lazy high profit margin finance industry. Robo-advice is built on using ETFs and further innovations in technology in coming years will certainly accelerate this trend.
So if you’re an institution be afraid and if you’re a consumer be excited, be very excited. Low cost, disruptive innovations such as ETFs and DIY super will lead to the increasing democratisation of finance.
Photo by Peter Parks and Getty Images