Young & Invested: Three ETF dealbreakers that stop me investing
Setting some ground rules in a flooded product market.
Welcome to my column, Young & Invested, where I discuss personal finance and investing for Gen Z and Millennials.
This column aims to be a resource for young investors navigating an ever changing financial, political and social landscape as they try to build wealth. Tune in every Thursday for the latest edition.
Edition 74
Every investor has their quirks.
I once came across someone who placed heavy emphasis on the aesthetics of a fund ticker in their analysis. I also know plenty of people who insist on owning whatever went up 100% last year. I’m not here to judge. Realistically, I fall somewhere on the spectrum of this idiocy.
Fortunately, I’ve set some ground rules or non-negotiables, if you’d like to call them that.
Show me the parent
Aristotle was a philosopher who spent his life wrestling with life’s great existential debates.
From tutoring Alexander the Great to founding his own school, he contributed much more to civilisation than anyone writing ETF columns on the internet ever will. Thousands of years later, I’m confident he never imagined that someone would be repurposing his ideas to talk about investing.
The philosopher is widely credited with saying, “Give me a child until he is seven, and I will show you the adult.” Now whether he actually said it and in those exact words, is beside the point. What he was trying to emphasise is how your environment shapes your outcomes. You can usually tell a lot about someone by looking at who raised them.
Funds aren’t children, but for comparison’s sake, I’m hijacking this assertion today. Show me the ETF and I’ll show you the type of parent it has.
I acknowledge this all sounds a little puritan. None of us had any control over who raised us or the inevitable quirks we developed as a result. Fortunately, one thing we can choose is the parent of our ETF. And unlike actual parents, ETF parents can be screened, evaluated and rejected without anyone needing therapy afterwards.
Behind every ETF sits a fund provider that you’ve trusted with your money and who makes numerous decisions on your behalf. Assessing the quality of a fund provider is essential to ensuring your financial outcomes are in good hands.
Now the exact nature of a ‘quality’ parent can be entirely subjective. Morningstar has an entire assessment pillar dedicated to this, but from a general investor’s perspective, there are a few markers that most people can observe.
The leadership behind your fund plays a huge role. The best firms have a clear vision and tend to make decisions that support long‑term investing, rather than short‑term sales targets.
Under good leadership, we can observe operational choices like thoughtful product design that doesn’t involve launching gimmicky strategies simply because they photograph well in a press release.
When a fund’s parent operates a few compelling strategies diluted by a shelf full of novelties, it generally raises a red flag for me. A lot of this is often evident in the marketing material.
Another aspect I use to assess quality is the turnover of funds that a firm has. That is, if a firm is constantly merging or closing funds, it usually means those products didn’t attract enough assets or simply weren’t working. Now intuitively cutting off the dead weight should promote success over the long term, but the results beg to differ.
Our data observes that firms with higher turnover that are constantly reshuffling product shelves often keep struggling in the years that follow. Meanwhile, those that make less changes delivered the strongest subsequent performance.
In short, if you notice a fund provider is always launching something new while burying last year’s mistakes, that churn is likely to weigh on you at some point.
For me, assessing a fund’s parent firm is not an optional step. Before I look at fees, index methodology, or assets under management, I look at who is running the fund. An ETF is only as strong as the organisation behind it and that is why parent quality is my first non‑negotiable.
The 0.25% rule
I like to think of myself as selectively stingy. McDonald’s is a perfectly reasonable dinner option, but no matter how close I am, I refuse to take public transport home after a night out.
I’m usually quite disciplined when looking for ETFs for my own portfolio. However, due to working in the investments industry, I often fall into an indefinite research rabbit hole. That makes defining what I want (and what I absolutely do not want) essential.
There are plenty of ways to evaluate an ETF for your portfolio. Once you know your goals and investment strategy, the next step is narrowing down the investment universe. This is where the difficulty appears and boundaries must be set.
As a long‑term investor, keeping costs low is a priority because I’m very aware of how fees compound over time. But I find the general term ‘low costs’ incredibly unhelpful. How low is low, really?
My informal rule is that I typically don’t spare a glance at products that have a total cost ratio above 0.25% p.a. I acknowledge that this number is somewhat arbitrary and I’m sure there are quality options above that line, but the point isn’t to find some sort of scientifically derived threshold. Establishing a simple cost screen narrows the field enough so that I can focus my attention where it matters.
Implementing this fee barrier makes my life a whole lot easier but also prevents me from being seduced by glitzy new product launches that often come with a high price tag.
Though I will admit this approach isn’t particularly useful in isolation. A more sensible starting point is to compare an ETF with others trying to do the same thing and set a price barrier based on the group. As investors, we want to know whether the fund is delivering exposure at a competitive price.
Is bigger always better?
Another non-negotiable is having a minimum figure for assets under management (AUM). And it’s not because size is synonymous with quality or because there’s psychological safety with larger funds. The logic isn’t quite as straightforward as ‘larger size means better fund’. The rationale is far more structural.
The mechanics of an ETF depend on liquidity, support from market makers and the ability to trade underlying securities without excessive cost. When an ETF is on the smaller side of its category, these mechanics become harder to maintain.
AUM is simply a reflection of how much scale the ETF has to work with. Larger ETFs tend to have tighter spreads, more reliable liquidity and stronger support from market makers. However, there is considerable nuance to this. AUM interacts with the underlying market so strategies like broad equities, large caps, bonds, all have naturally high capacity. They can operate perfectly well at enormous scale.
But not all strategies benefit from added scale. A small‑cap or a niche thematic strategy may hit capacity limits long before it hits headline popularity. Size only helps if the underlying market can absorb it.
Companies in select market segments don’t have market caps large enough to absorb significant inflows, which limits liquidity and narrows the fund’s opportunity set. And unlike mutual funds, ETFs can’t close their doors to new investors. This means they may have wider spreads and higher tracking difference. Though none of this is particularly dramatic on surface level, it may erode returns over time.
There’s also a commercial reality to screening ETFs by their size. Funds management is a business built on scale. A fund’s revenue is primarily driven by AUM and the corresponding management fee. For example, an active ETF with $10 million AUM and a 1% fee generates just $100,000 in annual revenue. Arguably, this is hardly enough to cover operating costs. In practice, funds need to reach tens of millions in assets before they become economically viable in the long term.
Research shows funds that don’t manage to attract sufficient AUM and have minimal trading volume face disproportionately higher costs relative to their scale, leaving them more vulnerable to closure. Of course, sluggish AUM growth is only one of the many reasons ETFs shut down.
In many markets, the industry rule of thumb points to funds needing roughly $50 million AUM to be profitable for issuers. Naturally, this isn’t a hard line. Profitability also depends on the level of management fees, complexity of running the strategy and the relative scale of the market. In Australia there are plenty of ETFs that sit below the $50 million mark and continue to operate. The key is whether they can demonstrate consistent asset growth.
