Insurance companies and public pension funds in Taiwan are leading an increasing embrace of local exchange-traded fund (ETF) markets, as they seek to achieve higher yields and liquidity at lower cost.

The ETF industry of Taiwan has been the world's fastest growing this year, courtesy of strong demand from local insurance companies, according to local fund industry promoters. At the end of June, the island's local ETF market had grown to a market capitalisation of $40 billion, or 30% of its public funds market – the highest proportion of any market in the world.

The growth of ETF interest looks set to continue and expand as local life insurers seek out a broader array of underlying assets. 

“We’ve seen a $20 billion AUM growth year on year ($25bn to $45bn) for the entire Taiwan ETF industry and more than 90% of that has come from insurance companies, focused on fixed income ETFs,” Julian Liu, president of Yuanta, the largest ETF provider in Taiwan, told AsianInvestor.

“Institutional investors as whole in Taiwan are more interested to use ETFs than two or three years ago,” agreed Eddie Cheng, quantitative investment manager at Cathay Site.

The island's insurers have sought out the products for two main reasons: yield and investing efficiency.

Many local fixed income ETFs heavily invest in US Treasuries, which yield more than the 1% typically offered by Taiwanese fixed income products. Plus the ETFs are denominated in Taiwanese new dollars, which means they are considered to be local products. This helps insurers avoid “currency exposure or the limitations of the overseas investment restriction,” said Liu. 

A 45% limitation on overseas investment for insurers was raised in 2018 by the Taiwanese regulator to 65.25%, combining foreign investment plus Formosa bonds (local issued, foreign company US dollar bonds).

Plus, insurers like the liquidity of the products. “When an insurance company needs a large clip, say $100 million, we can easily get our liquidity providers to provide that secondary volume,” said Liu.

Yuanta introduced the first local currency US Treasury ETF in 2017, and many others have followed suit. However, even US Treasury ETFs have begun to look less enticing for some Taiwanese insurers. That’s causing them to look further afield for better-yielding underlying assets in the ETFs.

“To cover their pay-outs, insurers need more than 3%, so with US Treasuries at fairly low levels in recent years insurers have begun looking at emerging markets, including China,” he said.

Cheng told AsianInvestor the insurers have bought ETFs that offer exposure to US treasuries, Chinese government bonds and corporate bonds in addition to Taiwanese fixed income.

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Asset owner interest in smart beta ETFs has also grown in Taiwan in recent years. However, this has come from more from pension funds than life insurers

Smart beta ETFs focus on low volatility and high dividend for equities, plus different credits and sectors within the fixed income space. The state-run Bureau of Labor Funds (BLF) has been the key trailblazer, having devoted internal resources to research different factor investing themes for several years. Its target allocation for ETFs, including such mandates, is 10% of its portfolio.

However, the pension operator has typically focused on using international market players to meet its smart beta ETF needs. “BLF typically gives its mandate to the global index fund providers. They will have an ETF index mandate with a global index company, probably BlackRock or UBS,” noted Liu.

Local asset managers have had more success with Taiwanese inverse ETF range of products, but these products haven’t typically been supported by institutional investors. Liu acknowledged that inverse ETFs are designed as a form of hedging or speculative tool for short-term traders, but he argued that well-managed pension funds should be able to use inverse ETFs.

“The BLF has the skills to invest in inverse ETFs for hedging purposes and the cost of this is much cheaper than doing it by the futures market,” he said, noting that the pension fund does use them to some degree.

Outside of Taiwan, other north Asian countries have also seen less prolific interest in ETFs. Korea has been a market innovator, first creating inverse and leveraged products in 2009, with Japan following in 2012. However, Korean government-owned pension funds are barred from using leveraged and inverse products. Korea Investment Corporation and National Pension Service have also investigated and invested some capital in smart beta strategies too. 

Meanwhile Japan’s ETF market has been skewed by the ETF buying policy of the Bank of Japan, which represents more than 75% of the net buying of local ETFs. Outside of this, defined benefit pensions and other institutional funds in Japan had invested a combined $12 billion of local funds and ETFs as of the end of March, according to data provider Broadridge.

ETFs have also gained popularity among retail investors, courtesy of online fund platforms such as Rakuten and SBI – including inverse and leveraged ETFs. However, ETF promoters in Japan are still waiting for a true mass-market to develop.

According to fund flows data provider ETFGI, ETFs continue to build their appeal across the globe. It reported on Monday (July 15) that the global ETF industry were $5.64 trillion of invested assets at the end of June, continuing a steady growth trend. And ETFs gathered global net inflows of $68.95 billion in June to bring year-to-date net inflows to $209.54 billion.

Source: ETFGI