Lack of innovation seen stifling Asia ETF market

Asian investor demand for exchange-traded funds (ETFs) created in the region is being hampered by a lack of product innovation, limited regulatory support and lack of understanding about these products, experts said at the Inside ETFs Asia event, produced in association with AsianInvestor, on November 9 in Hong Kong.

Yet while these issues are hindering the growth of ETF investing in the region, institutional, wealth and retail investors are all increasing their interest in the products. They are particularly interested in ETFs that focus on popular trends, such as technology. 

“Investors increasing want thematic exposures such as robotics, Fang (Facebook, Amazon, Netflix and Google) stocks, Chinese internet companies and cloud computing,” Brian Roberts, head of ETFs at Hong Kong Exchange (HKEX), told the audience of professional investors.

“If they can’t get these exposures in Asia, they will look to other markets to access such products. We need to speed up product innovation, especially in markets like Hong Kong, where the product line-up is lagging.”

Another participant at the event, Melody He, head of index solutions at CSOP Asset Management, noted that markets such as Taiwan have institutional investors like life insurers that are already adept at making traditional fixed income and equity investments. They are now looking at ETFs to gain more thematic exposures.

Far from being merely plain vanilla funds that track well known stock and bond indices, many ETFs today in the market have become much more targeted and sophisticated in their construction.

In addition to smart beta strategies, there are ETFs that are focused on factors such as low volatility or high dividends as well themes such as gender diversity, milliennials and environment, social and governance investing, as an ETF.com report noted.

However, according to HKEX data, more than 80% of the 136 passive products (comprising ETFs and leveraged and inverse [L&I] products) listed on the exchange were in traditional equity classes—Chinese, Hong Kong, Asia Pacific and overseas equities—with the rest focused on fixed income, currency and commodity products.

Regulations need to be more supportive in encouraging different kinds of ETF products if there is to be more innovation, argued Roberts. He noted that that in Asia, Korea has been the most supportive on the regulatory front in promoting ETF market growth.

There is growing anticipation in Hong Kong about a proposed ETF link with China, which would give millions of mainland investors access to HK-listed products. However, the programme is still at the discussion stage, according to a Bloomberg report in June.

Asia’s overall ETF market is still in its relative infancy: At the end of August 2017, ETF assets listed in Asia Pacific ex-Japan stood at $150 billion, up from $126 billion at the end of 2016 and $115 billion at the end of 2015, according to industry tracker ETFGI.

HK listing woes

While the regional growth of ETFs is considered to be taking place at a steady clip by most experts, Hong Kong-listed passive products have had a rough 2017.

In an October 31 report, the South China Morning Post, citing Bloomberg data, said investors had pulled out $4.8 billion from equity ETFs year to date, even as the rest of the region had seen net inflows.

In January, an AsianInvestor report had predicted that at least 26 ETFs would be delisted over the course of the year, signalling the biggest ETF shakeout in more than three years driven by cost pressures, fierce competition and low trading volumes.

Some major ETF players see these as teething issues for Asia's nascent passives industry.

“Index funds and ETFs have not been embraced as fully as they have been in other parts of the world," Linda Luk, managing director for retail and intermediary business for Asia at Vanguard, told AsianInvestor.

Nevertheless, she was an optimist about the instruments, arguing that investors would use them more as they better understood how they worked. Vanguard is the world's second-largest operator of ETFs.

Experts at the Inside ETFs Asia conference noted that investor perception of low liquidity has also kept ETF growth subdued, especially in Hong Kong. Chris Pigott, head of Hong Kong ETF services at Brown Brothers Harriman, said distribution also continues to be another big hurdle to their usage among retail and wealth investors.

“Banks continue to dominate fund distribution accounting for close to 80% of fund sales,” he told AsianInvestor.

They operate commission based models, typically charging a few percentage points of assets in distribution fees. This cost doesn't align well with the low-cost nature of ETFs, noted Pigott. “There is an opportunity for disruption to the existing distribution models and that is an area where we are starting to see online platforms start to focus.”

Given these challenges, merely improving variety in the ETF product suite, while helpful is unlikely to be enough, CSOP AM’s He said. “The entire ecosystem around ETFs in Asia needs to evolve.”

Wealth investor interest

Currently, demand for ETFs is growing the fastest in among wealth investors in Asia, although demand from institutions and retail investors is also growing, He said.

“Family offices in Singapore and Hong Kong, meanwhile, are looking to more advanced options such as leveraged and inverse (L&I) products to either enhance returns or hedge their portfolios,” she noted.

She said most Asian investors continue to use ETFs as a tactical tool, although lately some large institutional investors have started to consider using ETFs strategically in portfolios. Nevertheless, experts at the event acknowledged that Asian individual investors prefer to be active stock pickers, hunting for alpha.

One executive attending the conference, who sits on the investment committee of a multi-family office, told AsianInvestor that ETFs are unlikely to become highly popular because investors in Asia use ETFs only to gain access to markets they don’t know very well.

“As they become more familiar with stock movements, they sell the ETFs and buy the stocks they expect will perform better than the benchmark," said the attendee, who did not wish to be named.

His multi-family office is currently invested in ETFs.