Passive investment group Vanguard is tapping the Hong Kong market with today's listing of the city's first ETF tracking the US S&P 500 index.

The physically-backed fund will compete with Deutsche’s synthetic ETF which tracks US stocks. It comes as the S&P 500 has been surging to record highs and fuelling concerns about overvalued stocks.

However, the fund is being launched into a Hong Kong market which suffers from a lack of liquidity in non-China ETFs.

The listing today of Vanguard’s ETF will be competing head-to-head with Deutsche Asset & Wealth Management’s HK$14 billion ($1.8 billion) synthetic exchange-traded fund tracking the MSCI USA index. Vanguard’s newest ETF will have a total expense ratio of 0.25%, which is five basis points cheaper than its German rival.

“With the S&P 500 ETF launch, it will be another step in our journey to offering local Hong Kong investors access to broadly diversified core building blocks of the global equity market,” Hong Kong-based James Martielli, Vanguard’s Asia head of portfolio review, told AsianInvestor.

London-based research house ETFGI said there were more than 70 products listed globally providing exposure to the S&P 500 index. The biggest (SPDR S&P 500 ETF) had assets of $174 billion and an average daily trading turnover of $20.2 billion in April. ETFGI said Lyxor used to have two ETFs providing exposure to the US (tracking the Nasdaq 100 and FTSE RAFI US indices) listed in Hong Kong but both were delisted in 2012.

The launch of the Vanguard S&P 500 Index ETF will add to its existing line-up of products, with index funds tracking the Japan, Asia ex-Japan, Asia ex-Japan high dividend yield and Europe markets, covering around 80% of world equities, claimed Martielli.

But one concern is the general lack of liquidity of non-China ETFs in Hong Kong, including DB’s MSCI USA which has an average daily turnover of HK$900,000. This is in contrast to the HK$2.7 billion average daily turnover seen by BlackRock iShares’ FTSE A50 China Index ETF.

Martielli acknowledged this was an issue, but said that the selling point of the product would be to bring more diversification into a market where 111 of the 152 Hong Kong-listed ETFs invest solely in mainland China.

“[It is] correct that lots of the volumes are concentrated in a smaller number of [China] ETFs, but what we are bringing into the market is a little broader diversification and we are starting to get some really good interesting pick-up,” he said.

“We know that the ETF market is still in its early stages here in Hong Kong. We are expecting and we have been seeing gradual build-up of interest.”

Similarly, Martielli pointed out that the liquidity of an ETF should not just be measured by the trading volume on the screen, but equally relevant was the liquidity of the stocks that constitute the S&P 500.

Martielli also acknowledged that while Hong Kong investors can freely trade in open markets such as the US, listing the ETF in the city offers advantages to local investors including the ability to trade during Hong Kong market hours using Hong Kong dollars.

“Given the underlying stocks of S&P 500 which are very liquid, if a Hong Kong- or an Asia-based investor wants to trade and wants to know what price they are getting as opposed to waiting until overnight to when the US market is open, the ETF offers the convenience of being able to trade during Asian hours,” Martielli said.

But with the Hong Kong Exchange currently arguing for the inclusion of ETFs in the Shanghai-Hong Kong Stock Connect scheme, Vanguard could pin its hopes on mainland investors tapping into the market and injecting greater liquidity into its ETFs.

“The main reason for the listing was to offer folks here the opportunity to invest in a broadly diversified portfolio using low-cost ETFs, but if ETFs do end up on the Connect, that is something we would welcome,” Martielli said.

“Of course, we consider lots of different things when making any sort of decisions and [the stock link] is something we’ve considered alongside with other factors.”

However, the listing of the ETF in Hong Kong comes at a time when the US index has hit record highs in recent days, reaching 2,127 points at Tuesday’s close. The index, which has returned 2.28% year-to-date, has seen some fund managers such as BlackRock downgrade the US market because of concerns over high valuations after a strong run.