Asia’s retail investors are not showing the same appetite as institutions in the region or individuals in Europe or the US for passive strategies, including exchange-traded funds. There are good reasons for this, but also signs that the situation will gradually change.
The most commonly stated reason is Asian investors’ greater appetite for risk. But this mentality might be down more to the relative immaturity of the region's investor culture.
“One of our great hopes is that China [and other countries] can learn from the mistakes other countries have made,” said Chris McIsaac, head of planning and development at Vanguard. He noted that US investors moved from being stock-pickers in the 1960s and 1970s to users of mutual funds in the 1980s.
“The 1980s and 1990s was the time of the star fund manager, but the explosion of information since has made it harder for fund managers to beat the market, especially if they charge high fees," said McIsaac.
The learning process of Asian investors is likely to be faster, particularly given that investment returns look set to remain muted for years to come.
For one thing, wealthy investors are allocating to ETFs through discretionary portfolio management (whereby private banks invest their funds for a fee), said Kevin Hardy, Asia-Pacific head of beta strategies, and Deborah Bannon, investments business leader for North Asia ex-Japan at Mercer.
Yet for the broader retail investor base, progress is less simple. These investors need to better understand passive funds, but here the region’s fund distributors effectively act against them.
In Asia, banks are the primary distributors of mutual funds. They get paid commission by asset managers to sell them, which often reach 2% to 4% of the assets invested. Active managers then typically add around 50 basis points in management fees. The priority for the banks is to sell as many funds as possible; their appropriateness to the client is often a distant second priority.
But passive funds are low-cost, so cannot offer commissions. So bank distributors don’t market them, and they gain less recognition.
Similar problems lie with how private banks service clients outside discretionary mandates, said Jessica Cutrera, co-founder of the Association of Independent Asset Managers of Hong Kong. “I see little voluntary movement to passive [by private bank relationship managers]. In some cases, even when clients ask for it, the bankers won’t do it because they are not getting paid.”
While countries like the US, UK, Australia and Canada have introduced rules to cut back on retrocessions, Asia’s regulators have so far shown little inclination to ditch the commission-led distribution model.
Hong Kong's Securities and Futures Commission is consulting on proposals for increasing the level of fund fee disclosure, but it has stopped well short of moving to ban retrocessions.
William McNabb, chief executive of Vanguard, said: “Hong Kong is almost exclusively commission-based, China is heavily commission-based and so is Japan. Changing this will take time and might require a regulatory push in certain markets."
There are already some signs of this happening, at least in Hong Kong's and Singapore’s mandatory pension schemes.
In May, Hong Kong’s lawmakers approved a reform of its Mandatory Provident Fund (MPF) system, effectively censuring the 15-year performance of its actively run funds. Since the system was established in 2000 until the end of 2015 it returned an average annualised 3.1%, according to MPF Authority data. At the same time inflation was 1.8%, while the funds charged average annual fees of 1.56%. In other words, on average investors were worse off after 15 years.
Under the MPF core reform, MPF fund providers will have to offer low-cost default funds with a maximum 75bp fee, from April 2017. That is likely to mean forms of passive index funds or ETFs raising the profile and AUM of such funds. Singapore is looking at similar measures for its CPF system.
Another opportunity causing passive fund providers to salivate is the prospect of ETFs being included in the Hong Kong-China Stock Connect platform in 2017. That would give mainland investors the chance to access cheap and liquid offshore products.
China’s ETF market today is small, with only Rmb460 billion in AUM as of June, according to Wind Information, but it has major potential. Alibaba-owned Tianhong Asset Management, operator of hugely successful money-market fund Yu’e Bao, is preparing to enter the ETF market.
“Everyone is waiting for the big one – ETFs on the Connect programme,” said John Davies, global head of ETFs at S&P Dow Jones Indices, who also points to the entrance of robo advisers utilising ETFs as another encouraging step.
Demand among Asian institutional investors for passive funds looks set to remain robust, and progress among retail investors should slowly follow.
See the November issue of AsianInvestor magazine for the full feature on the development of passive investment in Asia.