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The past couple of years have seen an explosion in activity in ETFs outside Europe and the US. And it shows no signs of abating, despite recent disappointing market conditions which have led some investors to turn away from indexed products.
Key developing markets include Japan, Hong Kong, Australia and South Africa with South Korea set as the next market to enter the fray, when LG and Samsung launch two ETFs each later this year, advised by SSGA and BGI respectively.
Despite recent drops in trading volumes following uncertain market conditions, by far and away, the biggest ETF success story so far is Japan. Little over a year old, Japan is now the world’s second largest ETF market in terms of assets, with $16.5bn (E17bn) under management shared between four different managers: Nomura Asset Management, Daiwa Asset Management, Nikko Asset Management and BGI. ETFs were introduced there following legislation that required Japanese banks and insurance companies to relinquish all of their cross-share holdings by late next year, when a limit will be set on their equity holdings. “Japanese banks have been looking how to disperse of these equities – and they have taken baskets and baskets of cross-shares and converted them into ETF shares,” says Mark Roberts at BGI in London. As a result $9.9bn has been raised this year alone, according to Morgan Stanley figures. There are now 17 listed ETFs in Osaka and Tokyo which track incarnations of the Nikkei and TOPIX indices and offer investors sector plays in Electrical Appliances, Transportation Equipment and Banking. The largest ETF is the Tokyo-listed TOPIX ETF, with just over $8bn under management and with a daily share volume of $8.45m (July figures).
Increased investor interest is expected when Nasdaq launches its own ETF on the Japan Nasdaq Market later this year, which will allows investors to trade the Nasdaq-100. The Tokyo Stock Exchange has also signed an agreement with AMEX, which will eventually allow cross-listing of ETFs across the two exchanges.
In terms of institutional interest, according to Yoshihiko Tosen, executive director, equity product group at Morgan Stanley Japan, while they only make up around 10% of investors, Tosen says as much as 80% of ETF assets come from an institutional investor base. The level of Japanese pension fund money within that figure though is “almost zero”, which Tosen puts down to a reluctance from plans’ investment managers to recommend the funds, as well as a reluctance from the pension plans themselves to pay any additional fees. “I would expect that the management fee for the active managers is around 50 - 60 basis points. So 22 basis points for the passively managed ETFs might look too expensive.”
Overseas demand has mainly been channelled towards Nomura’s TOPIX and NIKKEI 225 funds. Japanese ETFs can be traded by European institutions by using private placement rules, with the exception of investors from France, Spain, Italy and Portugal, according to Tosen, who adds that investors should be aware, that unlike the US, Japanese ETFs are subject to liquidity freezes. “Japanese ETFs, except for those managed by BGI, have blackout days where we cannot create or redeem. On those days, the liquidity transfer mechanism doesn’t work.”
There are currently four ETFs listed on Hong Kong’s Hang Seng Index. Three of them are operated by BGI – iShares MSCI China Tracker, iShares MSCI-South Korea and iShares MSCI-Taiwan, the latter two which are US-listed ETFs cross-listed in Hong Kong. They are all overshadowed by the mammoth $3.3bn Tracker Fund of Hong Kong (TraHK), launched by the Hong Kong government and managed by SSGA. TraHK opened for business in November 1999, following the government’s decision to dispose of its sizeable portfolio of Hang Seng shares with minimal repurcussions on the market. At IPO, the fund’s issue size was US$4.3bn. “It was the largest IPO ever done in Asia at that time,” says Justin Pascoe, director of investments at SSGA in Hong Kong, adding that the fund attracted subscriptions from over 180,000 retail investors at launch. The current split between institutional and retail investors is 50/50. “For investors that are looking to buy into Hong Kong on a diversified basis, you have a choice of futures versus the ETF,” says Pascoe, adding that for a Hang Seng monthly rolling contract the annual costs would be 1% compared to an ETF which would charge 0.15%.
A number of Hong Kong defined contribution schemes have been offering the TraHK fund as an option to their employees, and a further inflow of funds is expected in light of changes due on the investment restrictions placed on Hong Kong’s Mandatory Provident Fund, which will allow investors to place up to 100% of their assets into index products, including ETFs (it is currently set at 10%).
The Hong Kong Exchange (HKEx) has also teamed up with S&P to launch a new set of indices; the large cap S&P/HKEx 25, the S&P/HKEx MidCap 25; and the S&P/HKEx SmallCap 50. In addition, a composite index of these three indices will be launched under the name of S&P/HKEx Composite, as well as a brand new index covering Hong Kong’s Growth Enterprise Market.
The new indices will no doubt raise the possibility of new ETFs to track them, which could include SPDRS style funds launched by S&P and HKEx themselves. SSGA has no immediate plans to launch any other products on the market, mainly to avoid cannibalising its existing product. “With ETFs liquidity is the key driver of the instrument and if you have competing products it fragments the liquidity,” says Pascoe.
Australia entered the ETF arena last August when SSGA launched the first two out of its existing set of three streetTRACK funds. A year on, SSGA remains the only provider of what Australians would terms as “classical ETFs” in this market. There is a retail alternative called “Hybrid ETFs”, which are actively managed funds operating on a much higher management expense ratio that allow retail investors to buy units in listed institutional equity funds.
SSGA currently runs a total of AUS$300m (E170m) under management split between its streetTRACKS S&P /ASX 200, streetTRACKS S&P /ASX 50 and streetTRACKS S&P /ASX 200 Property funds, all of which are listed on the Sydney Stock Exchange. SSGA’s flagship 200 fund holds the majority of these assets with around $78m in its chest and according to SSGA director of operations James McNevan, it is consistently the highest traded security in its sector, with a daily share volume of between US$6-7m.
The take-up with these funds, have come ‘overwhelmingly’ from the institutional investor base, with McNevan estimating around 90% of investors in the 200 fund are institutions, namely local superannuation funds, investment managers and corporates as well as North American and Asian pension funds and hedge funds.
“It is still early days in Australia, so this is an education process,” says MacNevan. “But there are superannuation funds who are using ETFs as long-term investment vehicles.”
South Africa currently has three listed ETFs; SATRIX 40, SATRIX Industrials and SATRIX Financials, all of which are managed by a coalition of JSE Securities Exchange, Gensec Bank and Corpcapital Bank. The first of the ETFs, the SATRIX 40 which was launched in late 2000, currently has US$413m under management with an average daily share volume just shy of US$0.7m, according to Morgan Stanley figures. In total, South African ETFs represent $553.7m of the global pool of assets.
While the majority of investors in South African ETFs have come from a retail base, recent legislation which allows the purchase or ETFs by unit trust managers, should boost institutional interest.
For international investors looking for exposure to these markets there are a number of considerations: tax can complicate issues if the ETF is not registered for sale in the investor’s prospective market; investors in UCITS funds may not be able to access the ETFs at all as they likely won’t fall within the predefined list of UCITS-approved investment vehicles; and then there are the benchmark risks involved with trading country ETFs not listed on their local exchange. But often the decision to invest in international ETFs is down to a question of logistics.
The US-listed iShares MSCI-Australia fund, for example, with just over US$85m under management offers non-Australian investors an alternative to shifting their assets to Sydney, though SSGA’s MacNevan argues that the trade-off for investors is that they will likely lose out on bid-offer spreads due to the simple existence of time zones. “When it comes to the efficiency of pricing, you’re able to price it in real-time which makes it competitive,” he says. “For the Australian ETF in the US, by definition the spread has to be broader. You are trading the ETF in New York but the market makers don’t have access to the underlying securities. In Australia, when they are pricing the ETF, they are pricing the underlying securities at the same time – in the US, these securities are already tucked up in bed so the market makers don’t have the ability to accurately match them.”

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