Plenty room for growth in Asia-Pacific
Demand for ETFs has been consistently rising
By David Macfarlane
Hong Kong introduced the concept of exchange traded funds (ETFs) to the Asia-Pacific region back in August 1998 when its government acquired a substantial portfolio of Hong Kong shares during a market operation. The government then established Exchange Fund Investment Limited (EFIL) in October 1998 to advise on the disposal of this portfolio in an orderly manner.
To avoid any disruption of the market, the government decided upon a stock neutral solution in order to dispose of these shares. In November 1999, the government’s first move in its disposal programme was to unveil an ETF - the Tracker Fund of Hong Kong (TraHK). This fund met these requirements and added depth to Hong Kong’s capital markets.
State Street Global Advisors Asia Ltd (SSgA) was appointed as the fund manager and State Street Bank and Trust Company as the trustee of TraHK. With an issue size of HK$33.3 billion (US$4.3 billion), TraHK’s initial public offering (IPO) was the largest IPO ever in Asia ex-Japan at the time of launch. As of October 22, 2010, the fund’s AUM stood at just under HK$50.5 billion (US$6.5 billion).
Given the intense interest in allowing the government to be able to sell some of its equity holdings, competition was rife for the mandate.
Hon Cheung, regional director - Asia, official institutions group, State Street Global Advisors Asia Ltd, explains that the main basis for SSgA’s proposal was that the firm believed the idea of an index strategy was one that the government would be comfortable with, i.e. a more passively engaged strategy as opposed to an active strategy. The other reasons were simply that the lower-cost nature of a passive strategy was quite consistent with the type of goals that the government had set out in terms of making the Hong Kong equities more widely available to the investing public.
"If you look at the specific processes that were put in place for the mandate, then there is, for example, an independent supervisory committee whose role is to review the development of the fund and the performance of the manager. That’s a specific element that relates to the TraHK itself," says Mr. Cheung. "From a general perspective, ETF is our business, so the creation of an efficiently run ETF is essentially part of SSgA’s DNA - we launched the very first ETF, the SPDR 500, back in 1993, and since that time we’ve created a number of leading-edge products within Asia-Pacific. SSgA’s leadership position in the ETF space coupled with our performance record for the TraHK shows that we have been meeting our investment objectives very successfully."
TraHK laid the groundwork for the launch of what is now a very vibrant ETF market across the whole Asia-Pacific region. According to Mr. Cheung, prior to the TraHK, questions were being asked as to whether Asian investors had any appetite at all for passive investments and strategies and whether they even knew what ETFs were. The perception was that Asian investors were more interested in thematic investing or investing in single stocks. "I think the TraHK essentially put an end to these misconceptions and helped create what is now an incredibly active and liquid ETF market across the Asia-Pacific region," he opines.
Opening the floodgates
In 2002, Taiwan’s regulators, having observed the success of TraHK, hosted a meeting with several investment trust companies in Taiwan to discuss the possibility of launching a similar product in Taiwan. Polaris SITC noticed the good showings of the SSgA SPDR and BlackRock iShares and decided to launch its ETF business in Taiwan. "Polaris SITC believed that with the introduction of ETFs in Taiwan, it would bring a new horizon to investing," says Julian Tsung-Sheng Liu, CEO of Polaris SITC.
He adds: "With the birth of the ETF, it created a little more opportunity for institutional investors to arbitrage within the market. They also provided a more transparent and easier and cheaper way of investing in both familiar and unfamiliar markets."
Chan Kum Kong, director of equities, DBS Asset Management, revealed that DBS began its ETF operations in 2005 with the launch of its ABF Singapore Bond Index Fund, which offered Singapore dollar denominated debt to investors. The objective was to provide simple, low cost, efficient and transparent investment vehicles to investors.
"The ABF Singapore Bond Index Fund was launched with the support of the MAS as an effort to encourage the development of the bond markets in Asia and to allow greater retail participation in fixed income products through relatively lower ticket sizes. Subsequently we began to use ETFs as building blocks for portfolio allocation, and other balanced products which offer combinations of equities and bonds," he comments.
Mr. Cheung of SSgA points out that ETFs form an important part of the capital market structure. "They are very much integrated into the whole machinery of an efficient capital market - for example, the TraHK tracks the Hang Seng Index and there are futures against that index, so there is a lot of activity that surrounds the arbitrage between the futures market or perhaps the ETF market. In addition, we see arbitrage between the ETF, the TraHK, and also the underlying cash market i.e. the constituent companies making up the Hang Seng Index."
He continues: "This three-way arbitrage is fundamentally good for investors: it creates a more efficient price discovery process; it creates tighter prices; and it reduces pricing inefficiencies where there may be big deviations between, for example, the futures price or the underlying ETF price or indeed the underlying price of the securities. The TraHK has clearly had a very significant impact; it is obviously a very large ETF and a very prominent one, where we have a very large panel of authorised participants who are very actively trading the ETF and also trading the other cash and futures markets as well."
According to Mr. Chan of DBS AM, the market for ETFs has come a long way since its introduction in the late 1990’s. "There has been an increase in awareness and understanding of ETFs and how they work among retail and institutional investors," he says. In Asia, there were only six ETFs available in 1999; by 2004 they were up to 50, and by April of 2010, that number had risen to over 220. Mr. Chan points out that the demand for ETFs has been consistently rising, and the recent market volatility that began in 2008 with the mortgage crisis caused a shift in investor’s risk appetite. In 2009, many investors turned to ETFs for greater transparency in relation to costs, holdings, liquidity and product structure.
"Many institutional investors, family offices and retail investors have understood and accepted that ETFs can be used to equitise cash and to gain exposure to equity sectors, country, regional and international market indices, government and corporate bonds, and money market and commodity indices. In terms of assets, the ETF industry in the Asia-Pacific region has grown tremendously over the past decade, increasing from about US$40 billion in 2005 to about US$70 billion today," claims Mr. Chan.
Polaris became a pioneer in the ETF industry when it launched the first cross-listed ETFs between Taiwan and Hong. "We saw the advantages and the simplicity of ETFs as an investment tool as they can help those investors who wish to participate in a certain market but do not have the ability or knowledge to do so. Therefore, offering ETFs is a better way to invest in countries that may be difficult to access," says Mr. Liu. "I believe we need to provide a product that can diversify investors’ investment portfolios."
On the back of tremendous growth in the region, the big question is whether investor appetite for ETFs can be sustained or not. Mr. Liu of Polaris SITC says demand for ETFs has been increasing. However he goes on to warn that managers need to be very diligent when offering different ETF to investors as there may be different underlying results.
Mr. Chan states that investor appetite for ETFs will not just be sustained, but will continue to grow progressively in the coming years. He says ETFs have not achieved the same market penetration as an investment tool in Asia compared with the US or Europe. "The number of listed exchange traded products (ETPs) has increased almost 200% since 2007. Many exchanges in Asia have also expressed their interest to increase the trading in ETFs on their exchange in terms of volumes, and increase the number of ETFs that are listed for trading. We expect a strong annual growth rate of between 20-30% in the ETF space in the coming years," Mr. Chan says.
Mr. Cheung believes there are still many more opportunities out there in the Asia-Pacific region and there are a number of reasons why the market can be opened up further. He points to the huge ETF growth in the US and says it has been the creation of independent financial advisors (IFAs) who basically extract an advisory fee and as a result try to produce the best possible outcome for the investors - good performance retains clients. "If you compare that model to a sales and commission-based model that is quite common with the bank and the fund distribution community in Asia-Pacific, you can see that the commission-based model obviously results in other products other than ETFs being positioned simply because they may be more from a sales commission perspective," he notes.
From the perspective of a custodian / service provider, Steve Cook, chief operating officer - global ETFs, BNY Mellon Asset Servicing, says he has observed only the very beginning of growth in the ETF market in the region to date. "The investment themes that have driven ETF growth to date will continue to increase ETF AUM, with pension funds, SWFs and other pooled asset structures allocating a greater percentage of their assets to beta investments. The potential for future growth is further bolstered as changes take place in buying behaviour towards fee-based accounts, which has been a major driver of ETF asset growth in other regions. Markets in the region such as Australia and India have a significant presence of IFAs (independent financial advisors), but most other APAC markets do not traditionally pay for investment advice."
Mr. Cook adds: There are many ETFs currently in the registration process in APAC and the launching of these products will also drive growth. New entrants into the region launching domestic ETFs or via the UCITS cross-distribution structure will cause the ETF market to grow in APAC. Investor education around the benefits of ETFs, especially their tax efficiency, will increase in the region as these new products are launched and drive future growth as well."
State of evolution
Mr. Cheung of SSgA says the ETF market in Asia-Pacific is rapidly changing and Asian governments through ASEAN+3 and other forums have been working very closely on this whole issue of integrating their markets more extensively. "I dare say in the future these types of issues will become easier for investors. We at State Street are also looking at the idea of creating funds that are much more portable across Asia-Pacific."
Polaris will continue cross-listing ETFs between Taiwan and Hong Kong, according to Mr. Liu. "We are also preparing to launch an additional asset class of ETFs focusing on fixed-income," he reveals. "Moreover, Polaris is also working with the regulators of Taiwan to launch leverage and short ETFs in Taiwan, as they have been widely used by the US and European traders."
"Going forward, we believe ETFs may not just be confined to passive strategies (index trackers)," says Mr. Chan of DBS AM. More active strategies could be offered to the market in an ETF structure. With investors continually receiving education and getting more familiar with ETFs, we at DBSAM will always be on the lookout to offer interesting products that to cater to market demand. As an example, we have seen a lot of interest in emerging markets and this could potentially be a space we might look at for an ETF in the future."
Mr. Cook of BNY Mellon Asset Servicing says the industry will continue to innovate and provide unique investment opportunities to individuals and institutions alike, in both passive and actively managed forms. "BNY Mellon has been at the forefront of innovation in the ETF space with the widest range of products serviced since 1995. As these products have been brought to market we have leveraged the experience and capabilities across all of our business lines to provide solutions to the challenges often experienced when introducing new products and concepts."