Asia’s weakness for indices

The region has among the most investing indices in the world. This is partly because of the undeveloped nature of local markets and isn't ideal, say investment industry figures.
Asia’s weakness for indices
A new survey estimates that Asia leads the world — alongside Europe — by number of market indices. However, some professional investors question their value. 
The study by the Index Industry Association shows that the Asia-Pacific and EMEA regions each account for 24% of the 3.14 million equity indices globally*. Global indices make up another 29%, while US markets comprise just 9%.
Rick Redding, chief executive of the New York-based IIA, which represents index providers, said the proliferation of Asian indices is evidence of the high level of scrutiny that Asian institutional investors place on their managers. 
“It is part of the wider benchmarking trend [among institutional investors] to see whether active managers are providing value” within the constraints provided by the investment mandate, he told AsianInvestor.
Most indices are employed by active investment managers to benchmark performance but investors use them too for similar reasons – to monitor the performance of active managers. A growing number also form the basis for passive, index-tracking funds, although that number remains relatively small with just 1,219 exchange-trade products in the Asia Pacific region alone, according to data provider ETFGI. 
Despite their evident popularity, some leading investment industry experts warn against relying too heavily on benchmarks.
“In general [in Asia, as elsewhere], we keep it simple and use an index that represents a broad investment universe for a particular investment strategy,” said Ronald van Dijk, a managing director in capital markets investments at APG, which manages a combined €475 billion for several Dutch pension funds, 75% of it internally. “In this manner we avoid that we implicitly outsource active investing to an index provider or advisor.”
In places like China, though, it is hard to avoid using index benchmarks due to the opaque nature of investment markets. 
“[China contains] many off-balance [sheet] activities, products or investment vehicles. Therefore, a reliable and transparent index system is a good start for [investors’] development,” Frank Lee, senior investment strategist for the wealth management business of DBS Bank in Hong Kong, said.
Problem is, that can make them susceptible to abuse, as Ashley Dale, chief marketing officer of Harvest Global Investments in Hong Kong, notes.
“There are many opportunistic index providers trying to benefit from the fragmented nature of markets, especially in China,” he told AsianInvestor. “Once one index has maximised its effect, they create another — which asset managers may feel obliged to pay for if they want to stay relevant to perceived client demand.”
More generally, investors across Asia are reliant on indices because the region is undeveloped in terms of “the accessibility of investment assets, the reliability of centralised intermediaries, and the sophistication of individual — and even institutional — investors,” DBS’s Lee said.
As such, equity markets with reliable and easily understandable indices are a good (or even the only) indicator of investment performance in some parts of the Asia-Pacific region, so they attract the attention and resources of locals, he said. 
Even so, investors need to be fully aware of the limitations of indices, such as survivorship bias (where poorly performing companies or those that fail completely are removed from the index, presenting a more optimistic view of performance in the sector than the reality), Lee added.
He also expressed concern at limitations due to “the oligopoly of index development” where a small number of firms run the majority of indices.  “Renowned providers like MSCI and FTSE dominate the market, especially in emerging markets or Asia Pacific, and comparatively undeveloped financial markets.”
New EU regulations could compound the problem by making it harder for smaller local index providers, Redding said. Since January, index administrators (and therefore managers) must comply with the regulation regardless of where they are based if any of their indices are used in the European Union. In such cases, both the index administrator and the index must be individually approved, which increases the compliance costs associated with creating an index.
“Before this, technology meant that all you needed to create an index company was a good idea. [The new regulation] will make it harder for innovative new firms to enter the market,” he said.  
* The IIA survey covered indices provided by firms that neither trade the underlying constituents nor create products based on them. Including fixed income indices, the total comes to 3.28 million.
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