Paul Hoff is the Tokyo-based Asia-Pacific managing director of index provider FTSE Group. He opened the group's first office in Tokyo in January 2003. He is responsible for FTSE's activities in the whole of the Asia-Pacific region including managing the index provider's regional headquarters in Hong Kong, which started operating in 2001. He oversees business development in the region and works to develop further partnership initiatives in the local financial communities. He also directs the sales, marketing and client services functions for the region. Hoff shares with AsianInvestor his views about the ETF market in Asia and the prospects for growth in this space.

This is the first of a two-part interview.

Could you talk about FTSE's history in the ETF market in Asia?

Hoff: For the region, the first ETF for us was the Taiwan Top 50 Tracker (TTT) Fund by Polaris in Taiwan. This was a collaboration between FTSE and the Taiwan Stock Exchange. The exchange wanted to have a national ETF and a new index that would be more tradable to represent the large-cap sector of the market. We continue to create indexes in Taiwan that are generally designed for use as ETFs. By having a tradable structure that reduces the number of stocks, you can actually capture the movement of the market through an index. Plus, they are free-float adjusted, liquidity-screened and are one of the best tools needed to run a tracker fund. The index itself launched in the last half of 2002. The Taiwan government, the regulator, the central bank all worked to change over 300 items in regulations, rules and laws to accommodate an ETF. Since then, FTSE has been active in licensing ETF issuers across Asia including in Hong Kong, Singapore and Malaysia across a range of asset classes.

How has FTSE evolved in the ETF space in Asia since 2002?

We have worked closely with various exchanges. We have been collaborating with Singapore Press Holdings and the Singapore Exchange to build indices for ETFs in Singapore; in addition to having State Street change to the new FTSE calculated Straits Times Index, DBS has also launched an ETF on the back of the new Straits Times Index in February this year. We work with Bursa Malaysia to create new indexes there and AmInvestment Bank decided to create Malaysia's first equity ETF using the FTSE Bursa Malaysia Large 30 Index.

The China indices, through our FTSE Xinhua joint venture, have been very successful globally with investors wanting exposure to the China market. We worked very closely with BGI, which created two ETFs based on the FTSE Xinhua China 25 Index; one listed in the US and one listed in Hong Kong. The further away you are from China, the more the iShares FTSE/Xinhua China 25 is used as it acts as a proxy for access to the China market and been very popular in the US and in Europe. When you are closer to China, people want access to the A shares and that's when the iShares FTSE/Xinhua A50 China Tracker becomes used a lot under the QFII programme. A number of investment banks have used that ETF for structured products and participatory notes, and there are warrants on the back of it also.

Where do you go from here in terms of expanding your share of the indices used in the ETF market in Asia?

We are continuing to work with managers and ETF providers. They are looking for special themes and customised tradable indices for the ETFs they are attempting to create. That's going to be one of the major drivers for us going forward.

Is the ETF space a big source of your business growth in Asia?

It is a good source of growth for us. By capturing specific asset classes, you get the assets under management and you get the fees associated with that. There is a bit of crossover as well. One of the major areas of growth has also been the non-price indices and we're looking to see ETFs on those indexes. We also look to develop new indices and work with new issuers in markets which are expected to grow their ETF range such as Australia, Singapore, Malaysia, Taiwan, Japan and so on.

You have a big lead in Asia in terms of the AUM and daily turnover of ETFs benchmarked against your indices. I see, though, that a large part of this is due to the success of the iShares FTSE/Xinhua China A50 Tracker.

The ETF market is quite interesting in the sense that you see a large amount of assets in some indices and then very small in others. For instance, Taiwan is a successful market with over $1 billion in the TTT whereas the other ETFs are much smaller in size and have less trading volume.

Asia has been a big institutional market for ETFs. When institutions are looking to invest in ETFs, they are looking at using them as part of their core portfolio. Trading of ETFs in Asia hasn't become as sophisticated as it is in the US or even in Europe.

The bulk of ETF assets in Asia are with institutional investors?

Yes, however the iShares FTSE/Xinhua A50 Tracker in Hong Kong, for example, has attracted a big retail following because it gives people access to the A share market.

Are the underlying assets determining the success of an ETF rather than the innovation involved in the product?

I think so. We are looking to do other kinds of ETFs. We have licensed short ETFs and inverse ETFs and others in Europe. These are quite innovative, but then they need to be understood by investors. Some of the more sophisticated and complex ones will appeal to the more sophisticated investors.

Do ETFs appeal more to conservative investors?

Not at all. Hedge funds use ETFs a lot because of the liquidity they offer. They are also inexpensive and are representative of various asset classes. We'll have to see how the education process continues in Asia. We have a few more years until we reach the level where we will see a whole lot more investors using the ETFs other than for the large-cap exposure.

In all cases, the investor needs to look very carefully at the underlying stocks of an ETF. I offer a word of caution: the indexes which the ETFs are based on are also generally down, just as individual stocks are. Once assets are in the ETFs, that means the share trading of those particular stocks that are in the ETF are going to be locked up within the ETF itself and that might provide some stability and less volatility because they are going to be in that index fund.

Do you attribute your gains in ETF market in Asia mainly due to your relationship with the exchanges of with the ETF providers?

Both. We work with a number of exchanges very closely, creating new index series for which can act as flagship indices which represent the market and are appealing to ETF and product issuers. For the providers, we are trying to help them in terms of identifying new asset classes and working on customised indices if necessary. The environmental ETF to be issued in Japan is a good example of this.

The April edition of AsianInvestor magazine will contain a feature on the ETF market in Asia.