Asian institutional investors are shunning fixed income ETFs listed in the region due to lack of liquidity and product choice, a bad situation made worse by recent market volatility in the wake of US Federal Reserve action.
While asset owners and managers incorporate equity ETFs alongside their actively managed portfolios for short-term, tactical purposes, the same is not true of bond ETFs.
Fixed income ETF products account for just 5% of Asia's entire ETF market, which stood at $151.1 billion in total asset as at end of July, according to data provided by research firm ETFGI.
Ben Rudd, head of overseas investment at Ping An of China Asset Management (HK), says his firm does not own Asia-listed bond ETFs as the market is not sufficiently developed for institutional investors.
The firm runs HK$27 billion ($3.5 billion) in assets, which includes the foreign portfolio of its parent – Chinese insurer Ping An Life – as well as third-party funds. It also manages both synthetic and physically backed A-share ETFs.
Ping An prefers ETFs that track liquid underlying securities and avoids those that account for a substantial portion – say, more than half – of a particular market’s assets, to protect the firm from investor redemptions, Rudd adds.
While it’s easy to analyse the liquidity of underlying listed equity markets, he says, it’s difficult to do similar analysis for bonds, as data on over-the-counter securities does not come from a single source. The fragmented nature of Asian markets makes this an even tougher prospect, illustrating the uphill battle that ETF managers face in the region.
A leading ETF asset manager on a recent bond ETF roadshow noted that some of the first questions asked by institutional investors were centred on liquidity. Many view Asian bond markets as opaque compared with equity markets.
Some institutional investors believe the only way to get access to ETFs is through the primary market, or via creation or redemption through participating dealers, says one market-maker based in Singapore. They seem unaware of the role of ETF market-makers, which trade them on behalf of clients in the secondary market.
The OTC market has a different structure and price discovery process from the listed market – often bonds from the same issuer trade distinctly differently – so educating potential ETF users is essential, note ETF managers. This is particularly true for retail investors.
These challenges have been compounded by the recent market sell-off and volatility following the Fed's hints at tapering of its quantitative easing programme – this has broadly curbed global investor interest in bonds.
In the US, bond ETFs have received almost zero inflows year-to-date. Globally, there was an exodus from bond funds last month – in June, roughly $60 billion of outflows were recorded, the largest amount since the early 1990s, according to Credit Suisse data.
Firms such as BlackRock’s iShares and Deutsche Asset & Wealth Management argue they have early-mover advantages in the Asian bond ETF market – but even they have a long way to go.