Exchange-traded funds as single instruments are well known to many investors by now, but funds of ETFs (FoETFs) may be rather less familiar products, particularly in Asia.
Having assembled an experienced team of Asian asset-management executives this year, Lippo Investment Management plans to change that and is about to launch its first FoETFs, which will comprise 20 to 30 ETFs and is not authorised for retail sale.
China and Southeast Asia are two major regions of focus, says Arthur Wu, the Hong Kong firm’s head of sales and marketing. Some QDII investors are interested in the FoETF model, he adds, and there has also been “quite good” responses from small to mid-size institutions in China. “High-net-worth clients are also very interested, but more education is needed.
“The answer I always get initially is ‘we can buy ETFs ourselves, why do we need you?’,” says Wu. “After we explain to them all the extra work, fund screening, due diligence, macro overlay, asset allocation etcetera that is involved, they start to understand how our model works.”
Of course, this extra level of work requires an extra level of fees, but chief investment officer Conrad Cheng says these fees will be at “the lower end of the scale”. He declined to provide more detail.
To create its products, Lippo IM will use a top-down, macro approach to first decide on the asset types it wants to invest in, and will then screen ETFs from the entire universe of 6,000 products available globally. At least initially, its main focus will largely be on equity-based ETFs, but it considers commodity ETFs a good long-term bet, particularly at present.
“Currently, Western governments are adopting various forms of 'quantitative easing' to solve some of their economic problems” says Cheng. “Under such scenarios, global investors tend to favour real, tangible assets, such as commodities or property.”
Meanwhile, a fierce debate, particularly in Hong Kong, is raging over the risks of synthetically backed ETFs – those backed by derivatives contracts rather than actual stocks, commodities or bonds.
It was sparked by an article in Hong Kong's Next magazine, which noted that iShares’ popular China A50 ETF is backed by derivatives rather than the actual shares it purports to track – as are many of the ETFs in the market. (See the October issue of AsianInvestor magazine for a feature on this.)
Asked for Lippo IM’s view on the situation, and whether it favours synthetic or physically-backed ETFs, Sammy Yip, head of business and product development, outlined the firm’s approach to product selection.
“[When choosing ETFs,] we will look at all qualitative factors such as the underlying investment instruments and structure of the product and quantitative factors including liquidity, turnover, expense ratio and so on,” says Yip who joined from State Street Global Advisors earlier this year.
“It’s a hot topic to discuss synthetic vs physically-based ETFs,” he adds. “All things being equal – the underlying benchmark, expense ratio, liquidity levels etc – we would go for the physically backed ETF to minimise the counterparty risk.”
“But unfortunately we don’t live in an ideal world,” says Yip. “And there may not be too many cases where you basically have two identical products with the only difference being the physical versus the synthetic underlying.”
As a result, he says, in some cases synthetics are the only choice available or the more attractive choice because of having better liquidity, a better expense ratio, and so on.
Cheng adds that Lippo IM may also use other instruments in its FoETFs strategy. For example, the firm can partially hedge against certain market risks by using exchange-traded futures, something that is particularly useful in less liquid asset classes.
Beyond equities and commodities, Lippo AM favours offshore Chinese bonds and has appointed China Construction Bank International Asset Management as a sub-adviser on this market. The company cannot yet access renminbi bonds as it lacks a QFII licence and does not have enough scale to be eligible for one at present.
“A lot of people want to tap into China bonds but there aren’t any China bond ETFs available yet,” says Stanley Kwok, Lippo IM's chief executive.
Yip adds that this is one of the gaps in the ETF market, but he expects it will take more time for investors in Asia to get more comfortable with fixed-income ETFs, as they are a relatively new type of product.
Lippo IM has no solid target in terms of assets under management, says Kwok, who would only say that the firm is “in expansion phase” and would consider further hires as and when required.