Hong Kong Tracker Fund marks 10-year anniversary

The exchange-traded fund market has come a long way since the launch of the first Asia ex-Japan ETF a decade ago.

Believe it or not, it has been 10 years today since the introduction of the first exchange-traded fund in Asia-Pacific. Ten years ago Hong Kong saw the first ETF launch -- before Japan, before Australia -- as a response to the Asian financial crisis.

Yesterday, officials from the Hong Kong Monetary Authority and the Tracker Fund's manager, State Street Global Advisors, held a ceremony to commemorate the event.

Today, ETFs are a fast-growing part of the asset management business in Asia. For details on the latest developments, see AsianInvestor magazine's cover story for November 2009.

But, back in 1999, ETFs were completely unknown in Asia. The Hong Kong government, under the impetus of then-financial secretary Donald Tsang (the current chief executive), had embarked upon a controversial strategy to safeguard the value of the Hong Kong dollar by defending it against hedge funds, who were attacking it via shorting the Hong Kong stock market.

It is hard today to appreciate the awkward situation this had created for the Hong Kong government. Remember, this took place right after Hong Kong had become a Chinese special administrative region (SAR), and big global hedge funds were taking advantage of the collapse of the Thai baht to short Hong Kong stocks as a wedge to break the Hong Kong dollar's peg to the US dollar.

Tsang led the charge against these funds in 1998 by buying up Hong Kong stocks. Inevitably this generated very sharp criticism from many financial practitioners as going against the grain of Hong Kong's hard-won reputation as a laissez faire regime.

The Hong Kong government was in a bind. On the one hand, it felt its hand had been forced -- the viability of the currency regime was at stake. On the other hand, it was very obviously intervening in its capital markets. Had it not found a solution, this would have gone down as a massive error. It was a huge, huge risk.

The year is 1999 and enter State Street Global Advisors, then in Asia under the management of Vincent Duhamel, who is now head of Robert Miller's Search Group. Duhamel, a native of Quebec, had recently arrived in Hong Kong with an impossible mandate -- convince Asian institutions and governments of the value of passive investing. Good luck.

The Asian financial crisis and the attempt to break the Hong Kong dollar peg was a godsend to SSgA and the concept of passive investing. The Hong Kong government had been forced to buy HKEx stocks, but had no clue about an exit strategy. The government routinely lauded by America's Heritage Foundation as the exemplar par excellence of free-market rigor had just intervened in the local stock market in an unprecedented way.

SSgA made a simple pitch; why not gradually divest the government's position via an ETF? Launch it at a discount to attract retail and institutional investors, and sell off government stakes every quarter or so. Donald Tsang liked the idea and in practice it worked a charm.

At the time, the Tracker Fund was a real novelty but its genius was in its government backing and the generous discount it offered to Hong Kong retail investors (and global institutional investors) to buy the Hong Kong market cheaply. It set a precedent for other markets and today ETFs are common in the region, with the market worth more than $35 billion.

As AsianInvestor's cover story for November 2009 shows, it has been the rare blockbuster fund like the Tracker, usually backed by a government, that has dominated the region's ETF industry since.

Today ETFs are all the rage but it remains success stories like the Hong Kong Tracker that continue to dominate the business in terms of assets raised and market turnover.

Yesterday at a ceremony to commemorate the event, Hong Kong Monetary Authority chief executive Norman Chan had some interesting reminiscences. With a reference to the recent crisis, Chan began by pointing out that while the current focus is on how to exit stimulus packages, the HK Tracker involved "one of the most innovative, and dare I say elegant, exit strategies".

"The strategy, of course, was to dispose of the stocks acquired by the government in the stock market operations of the summer of 1998 with minimal disruption to the market," he said. The authorities succeeded by launching the ETF in November 1999 in what was then the biggest ever public offering in Asia, raising HK$33.3 billion from over 180,000 retail investors and institutions.

He cited as other obstacles that had to be overcome "the shadow of Y2K hanging over us" and many operational, IT, legal and regulatory challenges.

Chan also remarked on widespread concerns over how "unorthodox and unproven" such an approach was in Asia. Ironically enough, the investment banking community -- hardly known for its shyness to latch onto new concepts -- was "perplexed" at the plan to launch an ETF when a block trade or a convertible bond option was so much more familiar or safer.

What's more, "our legal advisers were perplexed that we should launch a fund through an IPO", he added. "Our global coordinators were amazed by our determination to create an innovative 'tap facility' to allow the continued block creation of more Tracker units from the remaining portfolio of shares." Chan also noted that no discount was given to the public at launch of the IPO; instead they were offered an innovative back-end loaded incentive scheme in the form of a loyalty bonus.

Yet, by April 2001 the government had recouped more than the HK$118 billion it spent propping up the stock market. In total it sold HK$140 billion worth of shares into Tracker, received HK$24 billion from dividends on its shareholdings and still retained $50 billion in the ETF's long-term equity portfolio when the "tap" into Tracker was terminated.

Joseph Marsh contributed to this story.

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