The use of ETFs as part of a mixed strategy of passive and active portfolio management is likely to grow rapidly in Asia, driven by organic growth among local investors and strategic asset allocation among players from outside the region.
“Many institutional investors are adopting a strategy of getting indexed and actively managed investments to work together,” says Jane Leung, Head of Product for iShares Asia ex-Japan at Barclays Global Investors.
Through its iShare product range, BGI’s 320 ETFs account for more than 50% of the market $797bn ETF market, according to research from Morgan Stanley. Leung explains: “They can be part of a core-satellite strategy. They can be used for tactical asset allocation, for example shifting between equities and bonds in anticipation of a shifting market. They can also be utilised on a buy-and-hold basis as part of a long-term investment strategy. Investors can tailor their portfolio to meet very specific risk-return requirements.”
Deutsche Bank is a relatively recent entrant to the global ETF arena, making its debut last year with US$20.5 billion assets under management (approximately 2.6% of the global market).
DB research shows that in 2007 Asia represented only 8% of the global market for ETFs in terms of AUM. The US has 71% of the market and Europe 18%. By the end of 2010, Deutsche estimates Asia could have increased its ETF market volume by around one third, to US$85bn. “We’re seeing more ETF managers coming to market in Asia with more products,” says Raimar Dieckmann, Senior Economist at Deutsche Bank Research in Frankfurt am Main, Germany. If that trend continues, a more competitive environment may help to push down administration charges.
Charges for passively managed ETFs traded in Asia are typically higher than for those traded in the United States. The SPDR Gold Trust ETF from State Street Global Advisors recently listed in Hong Kong charges 40 basis points per year of average daily net asset value for storing gold bullion in a bank strong room.
European ETFs including those cross-listed on Asian bourses charged management fees that averaged 34 basis points of NAV in 2007 according to Deutsche Bank Research. By contrast the SPDR S&P500 ETF in the US currently charges a net expense ratio of 9.45 basis points (0.0945%). Given the scale of charges levied on ETFs sold in Asia, it’s not unreasonable for investors to have high expectations of their performance. Managers of ETFs sold in Asia cite the lower volumes typically involved in Asia and the need to spend more on investor education and product promotion.
Deutsche Bank is one of several European institutions cross-listing ETF products on Asian bourses. Dieckmann thinks that European UCITS funds will do well in the Asian market.
Supporters of the UCITS regime say that it encourages transparency in fund management and thus builds consumer confidence. An example of this is in the use of swaps, which are considered important as a way for ETFs to limit index tracking errors. Swaps introduce an element of counter party risk, but UCITS III formally caps the use of swaps at 10% of a fund’s assets.
Sceptics say transparency is already built in to the ETF business model and that, in any case, consumers are protected by the regulatory regimes of the markets where the funds are listed. Commodity-based ETFs that avoid swaps and derivative trading arguably do not need UCITS levels of oversight.
The SPDR Gold Trust ETF is now listed on the Hong Kong, Singapore and Tokyo Stock Exchanges. The sole asset of the gold ETF is allocated gold bullion, according to Sammy Yip, Head of Exchange Traded Funds Asia Pacific for SSgA Asia. “Each share represents an undivided beneficial interest in a trust. We don’t enter into any derivative transactions. The gold is allocated so it can’t be lent to the market.”
Gold’s status a safe haven investment is undeniable after the recent spike when the banking crisis came to a head. “It does not correlate with other mainstream assets, which makes it an effective portfolio diversifier,” says Yip.
“We have access to a market maker that provides liquidity via our listing markets. As an authorised participant the market maker handles creations and redemptions directly with the trust. That continuous creation and redemption minimises errors in tracking the underlying indices.”
Deutsche’s Dieckmann also stresses the importance of tradeable market: “Liquidity is a valuable characteristic of ETFs, but more important is the tradability created by a market maker. On Asian stock exchanges trading volume is typically much lower than in Europe. But you have to differentiate between the level of on-exchange trading volume, and the level of potential for trading in ETFs. That’s where a market maker comes into play. For ETFs it’s a more enhanced function compared to say a standard market maker for equities. It’s a more enhanced value chain,” adds Dieckmann.