While institutional investors continue to pour into passive products, private bankers are resisting using them as they don't pay retrocession fees, said Jessica Cutrera, a co-founder of the Association of Independent Asset Managers of Hong Kong (AIAM). As for private banks that use passive strategies, they tend to lean heavily on proprietary products if they have that option, she told AsianInvestor.
Cutrera, head of operations and compliance at EXS Capital, a Hong Kong-based IAM, said she was basing these views on the porfolios she had been shown by clients, and noted that other AIAM members reported similar findings.
“When I look at the private portfolios constructed by private bankers, I still see predominantly proprietary products,” she noted. “I do not see a lot of diversification. I see little voluntary movement to passive. In some cases, even when clients ask for it, the bankers won't do it because they are not getting paid.”
Private bankers tend to deny that they favour in-house funds, stressing that they have open-architecture platforms and onboard the best-of-breed product in any given area, following stringent due-diligence processes.
But this is not generally the case, said Cutrera. “The argument I hear back from the private banks is that they know their own funds the best. But there is clearly a conflict of interest.”
Indeed, some private bankers privately admit that there is no incentive for them to use passive funds and that take-up would only increase if the fee-based model were to become a requirement or the industry norm. Banks currently get retrocession fees from funds they sold to clients.
Cutrera is a proponent of a fee-based business model, though that is not true of all AIAM members. Some charge a flat fee, some get paid based on performance and some receive retrocession fees. What is crucial is that AIAM members provide fee transparency to clients.
Unlike private banks, IAMs have shown growing appetite for passive investing, including smart-beta products, said Cutrera. “Smart-beta, which is viewed as cheaper form of active management, has a lot of interest for IAMs. All of us have more solutions to select from.”
There has been a trend for passive fund providers to reduce management fees; something that Cutrera supports. “As an association, our view is anything that increases efficiency and reduces costs for our clients is a good thing,” she noted.
However, she stressed the importance of monitoring the costs of such strategies, which can vary widely depending on the provider and the type of product. Some of Vanguard’s smart-beta funds, for instance, are cheaper than some companies’ traditional index trackers, she noted.
Cutrera cited as examples Vanguard’s US Dividend Appreciation Fund (which has a total expense ratio TER) of 0.09) and iShares' Core High Dividend (0.08 TER). She compared them to Guggenheim's S&P 500 Top 50 tracker (0.20 TER), which is a traditional index product.
Where funds are listed also has an impact, she noted: Vanguard’s US-listed FTSE Europe fund has a TER of 0.12, while the firm's FTSE Europe product listed in Hong Kong has a TER of 0.25.
“So you need to look at [products] on a case-by-case basis. You need to look at which market they trade,” she said. For instance, emerging-market products are likely to charge more because of the higher cost of trading involved.
Moreover, the total cost of investing in passive and smart-beta products is not necessarily captured in the TER, Cutrera cautioned. “I have seen cases, where a product has a much lower expense ratio but higher total costs because of rebalancing, trading and tracking costs. There’s a lot more than the headline number.
“Analysing a passive product might just take as much due diligence as [it does for] active products,” she added.
Jackie Choy, Hong Kong-based director of ETF research at consultancy Morningstar, has also pointed to the growing complexity of exchange-traded products and the implications it has for investor due diligence.