So far, so good

Category: Asia, China, Hong Kong, Global
By Hui Ching-hoo

China’s ETF market has yet to achieve critical mass

Although China’s exchange-traded funds (ETFs) have drawn significant inflows from retail investors this year, the market still lacks breadth and depth of functionality and capacity to attract institutional investors and fund of funds (FOFs), according to Harvest Global Investments (HGI).

HGI is the wholly-owned Hong Kong subsidiary of Mainland asset management giant Harvest Fund Management.

Robert Chen, head of asset allocation and passive investments at HGI, notes that the Mainland ETF market has been “booming” this year, with a substantial increase in new supply and trading volumes.

“We’ve seen 20 ETF listings in China for the first nine months this year, almost equivalent to the whole-year total of 2016,” Mr. Chen tells Asia Asset Management in an exclusive interview.

Mr. Chen cites Bloomberg figures as saying that the number has almost doubled from the 12-year average, where only a dozen ETFs went public in the market every year from 2005 to 2016.

The number of new listings is likely to reach a fresh high this year with several products in the pipeline, he adds.

Mr. Chen points out that the ETF market transaction value also underwent significant growth over the same period.

Figures from the Shanghai Stock Exchange (SSE) show that the bourse’s total ETF transaction value was about 658 billion RMB (US$99.25 billion) for the first nine months of 2017, surpassing the 651 billion RMB for all of 2016, he says

Meanwhile, FOFs, the investment strategy of holding a portfolio of other investment funds rather than investing directly in stocks and bonds, seems to be a new concept for Mainland investors.

In September, the China Securities Regulatory Commission gave six domestic fund houses the green light to set up mutual FOFs products.

“The emergence of FOFs will definitely be an impetus for the ETF market,” Mr. Chen says.

“FOF products are seeking to invest in active funds as well as ETFs for their portfolio allocation due to their broadly-represented market tracking capability,” he adds, noting that this will help to increase the breadth of the ETF market.

“In the past, a vast majority of the ETFs were equity-tracking. But now ETF providers are realising that they have to diversify their ETF line-up to track other areas such as fixed income and commodities funds so as to capitalise on the FOF market growth,” he says.

Despite the increasing market liquidity, Mr. Chen points out that Mainland ETF providers have only made limited headway in growing their AUMs.

“For example, ETFs are required to have a certain amount of AUM and track record to be qualified for the inclusion of FOF portfolio. Currently, outside money market funds, only a small number of ETFs are able to gather a meaningful size of AUM,” Mr. Chen says, noting that it will take time for China’s ETF market to become full-fledged.

In terms of institutional adoption, Mainland institutional investors are “very open” to using ETF products, but the market has a limited choice to meet their portfolio allocation requirements, Mr. Chen says.

For example, Mainland investors have a strong appetite to increase their overseas exposure, but there are only seven cross-border ETFs listed on the SSE, which is too few to meet the huge market demand, he adds.

“In some cases, institutional investors may prefer to select active managers even though their management fees are higher [compared to ETF managers] due to liquidity considerations and the potential to generate alpha from the market,” he says.

Product wise, Mr. Chen observes that smart beta products with low fee structures have been well-received in the market. In addition, ETFs, which provide a consistent performance on an absolute return basis, are drawing attention from institutional investors, he adds.

“Thematic and sector ETFs, especially for those capturing the concept of new economy and consumption upgrade, have also been very popular in the market,” he says.

China currently has 160 ETFs issued by more than 30 ETF providers.

According to Mr. Chen, the industry landscape has become increasingly competitive, such that newcomers might not find it easy to enter the market.

“The big chunk of the market has been dominated by the big names,” he says, noting that newcomers have to be more well-equipped in investor education and product promotion, and differentiate their offerings from their rivals.

“Overall, while being optimistic for ETFs’ future in the long term, I would not find it a surprise to see a consolidation in the ETF industry,” he adds.