Will funds of ETFs take off in Asia?

A panel hosted by AsianInvestor discussed this and other issues around exchange-traded funds, such as how Asian ETFs can move beyond a concentration on China products.
Will funds of ETFs take off in Asia?

Funds of exchange-traded funds are likely ultimately to gain traction in Asia, but a wider range of more focused products is still needed, said market participants on a recent panel hosted by AsianInvestor.

“Eventually there might be a time for active managers to talk about asset allocation products. Investors might want to buy funds of ETFs – if there is an attractive enough proposition, that might attract demand,” says Steve Chiu, chairman of the Institute of Financial Planners of Hong Kong (IFPHK).

Jonathan Horton, global head of exchange-traded products at index provider FTSE, agrees, citing the development of such products in the United States.

“If you look at the US, the development of intermediaries that are ETF-exclusive – and the rate of growth of these businesses – is extraordinary," he says. "They offer very good management fees for the portfolio and can make very good asset allocation decisions.”

Eric Pollackov, managing director of ETF capital markets at Charles Schwab Investment Management, echoes this view. “Ten years ago there were five people selling ETF model portfolios in the US – now there are about 500,000."

He points to Charles Schwab’s purchase in 2011 of fund-of-ETFs firm Windhaven, formerly known as Windward Investment Management. The firm had $4 billion in assets under management at the time of the deal, notes Pollackov, and now has over $17 billion.

Such development would be aided by regulation similar to the UK’s Retail Distribution Review, which effectively bans commission-based selling of products, says FTSE’s Horton. “The retail distribution environment in Asia is almost a brake on some of the innovations you’re seeing elsewhere. If those brakes can be removed, that would help the market to grow.”

Andrew Hua, Asia head of portfolio management at LGT Investment Management, notes that while his firm has not really considered offering funds of ETFs, he is seeing demand for different uses of ETFs.

“We have a couple of clients that want to rely on us for asset allocation and are not so interested in paying another manager for the active management,” he says. “This is a relatively new trend.”

However, Asia suffers from a relative lack of choice of locally listed products, with an overconcentration on Chinese underlyings, say panelists.

“We’re struggling to find ETFs covering other parts of Asia, because there’s so much focus on China,” says Hua. “So, for instance, we might look for funds that focus just on Korea and Taiwan together, but they don’t really exist. So you either buy an Asia fund that includes everything or you buy separate ETFs on the local exchanges in Seoul and Taipei.”

Many popular ETFs in terms of AUM or turnover in Asia are China products, agrees IFPHK’s Chiu. And differentiation between types of ETFs in each market is limited, in that you only have a choice of a few indices for each type of product, he adds. “I would like to see more differentiation within product types, in terms of China or even Asia products.”

Chiu would like to see more ETFs focused on individual sectors in China, for instance. “So that, for example, if the stock market falls, as in China recently, the ETF market for that country doesn’t simply collapse, because you can invest in different sectors in China that are outperforming.”

Still, there is likely to be a limit on how far ETFs develop, for the retail market at least.

There are some “very sophisticated products that will almost replicate hedge fund strategies, and we don’t think they will easily migrate into the retail environment”, says FTSE’s Horton. “But those are absolutely right for institutional clients. A lot of these smart-beta solutions will appeal to the institutional market.”

That said, if an ETF structure is too complex, “you’re basically replacing the job of the institutional investor”, says Marco Montanari, Asia-Pacific head of passive management at Deutsche Asset & Wealth Management.

Smart beta can be successful in Asia, he argues, as long as it doesn’t deviate too much from the benchmark index and doesn’t become too active. “In Asia and even Europe, my view is that the market is still not ready to accept active ETFs, because the investors are institutions, which use ETFs to implement their view.

*An extended version of this panel discussion appears in the September issue of AsianInvestor.

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