Asia has been slow to embrace exchange-traded funds (ETFs) , but local investors are warming up to the asset class, using it to gain risk-controlled exposure to specific countries in the region, says Daniel Farley, who heads allocation strategies for State Street Global Advisors’ (SSgA) institutional clients worldwide.

The region is home to 318 ETFs, with assets of $84.1 billion in exchange-traded products as of December 2010, far behind Europe’s 1,663 ETFs with $318.5 billion in assets, according to SSgA research. The market is dominated by the US, which has 1,111 ETFs and just over $1 trillion in assets.

While research house Cerulli Associates has previously suggested that relatively high management fees have hindered the popularity of ETFs in Asia, State Street takes the view that they are catching on for reasons that include liquidity, transparency and easy exposure to assets that can be difficult to access – such as China-listed stocks.

“Asian investors very much recognise the growth potential in their home or regional markets and they want to take advantage of that,” says Farley.  Part of the growth in ETFs regionally can be attributed to their targeted focus, he adds. “If you look at ETFs listed in the region, many of them are country-level funds.”

At the same time, ETFs are vying for investor dollars with hedge funds, which have come back into favour among investors on a global basis, according to reports released last week by Deutsche Bank and Credit Suisse.  

While SSgA does not deter its clients from investing in hedge funds, Farley warns that many of the different strategies available are reliant on markets that will move to what fund managers deem as fair value. “However, if fair value is not being appreciated by the marketplace, all the strategies fail at the same time.”  

Investors would do better with “strategies that do well when fair value doesn't”, says Farley, who lists managed futures and global macro funds as examples of “divergent strategies that do well when the market does poorly”.

Hedge funds themselves are increasingly active within the ETF space, Farley notes. ETFs enable hedge fund managers to gain exposure to stocks in specific countries or sectors, with less risk when compared with holding the securities directly.

However, on the short side of things, being an exchange-listed vehicle makes ETFs vulnerable to short-selling, which is said to account for more than half of hedge fund transactions of the product in Europe.

State Street, cognisant of the fact that some institutional investors will use ETFs with a short-term view – as opposed to a buy-and-hold asset – promotes the product as an efficient vehicle for providing either overweight or underweight positions when making tactical allocations.