Collateral opens door to A-shares

PUBLISHED : Monday, 05 December, 2011, 12:00am
UPDATED : Monday, 05 December, 2011, 12:00am


Although Exchange Traded Funds (ETFs) can be simple or complex, issuers say they provide access to investment themes and markets difficult to access using other types of investment tools.

As the number, diversity and volume of assets invested in ETFs in Hong Kong grows, issuers and regulators are keen to ensure that investors fully understand what they are buying and comprehend the risks and costs involved. Like individual stocks, ETFs provide investors with the flexibility to buy and sell on the major stock exchanges throughout the day, at the market price.

However, as more synthetic ETFs enter the marketplace, the Hong Kong Securities and Futures Commission (SFC) has subjected synthetic ETFs to greater scrutiny designed to strengthen protection for retail investors.

At the end of October, the SFC introduced new regulations and imposed additional requirements on the institutions that issue domestic synthetic ETFs, requiring them to increase collateral to at least 100 per cent.

Where traditional or plain vanilla ETFs buy and hold a basket of stocks, synthetic ETFs involve the use of collateral in the form of a swap with a counterparty. The use of synthetic ETFs are particularly popular in Hong Kong because they allow investors to participate in the mainland's A-share performance.

Nick Good, head of iShares Asia-Pacific, says iShares is seeing strong interest in its China A-Share products. 'These provide comprehensive access to the China market and the opportunity for investors to express their views on what is now the second largest economy in the world,' says Good.

Because only about 15 per cent of the companies listed on the China A-Share market also issue H-Shares on the Hong Kong stock exchange, Good says investors outside the mainland have limited options to access the A-Share market.

'Investing only in H-Share equities can tend to underrepresent areas including consumer staples, consumer discretionary and materials,' says Good. 'This has made A-Share ETFs, which allow investors to participate in the growth of the broader Chinese economy, attractive,' he says.

According to iShares data, the ETF market in Asia is growing. At the end of September, the number of ETFs in Asia Pacific, ex-Japan totalled 283, an increase from 200 at the end of 2010.

Good says investor education is available online, through ETF providers and intermediaries.

'We can do more to help educate retail investors, however, in the broad context thorough seminars and information provided by banks, brokerages, private wealth companies and sponsors, investors can find out how they can use ETFs and create a more diversified investment portfolio,' says Good. 'This is an area on which we place a lot of focus, but there is always more we can do to explain how essentially ETFs are good tools to improve the balance of a portfolio.'

Lisa Wang, State Street Global Advisors regional head of ETF marketing, believes ETFs offer an easy, cost-efficient way to incorporate various asset classes, investment styles, industry sectors and commodities to their portfolios. 'Because most ETFs are passively managed, they generally have low management fees and operating expenses,' says Wang.

At the same time, Wang cautions it is important to keep in mind that frequent ETF trading, which typically occurs through a broker, can significantly increase brokerage commissions potentially washing away any savings from low fees or costs.

As with all financial investments, Marco Montanari, head of Deutsche Bank's ETF business, branded as db X-trackers in Asia, says investing in ETFs involves some risks. These can include market risk, liquidity risk, tracking error risk and counterparty risk.

The key advantages of ETFs are they offer diversification, they are tradable like stocks and they are cost-efficient.

He says it is only appropriate to invest after understanding the relevant legal documentation. 'This applies to all financial products and not just ETFs,' says Montanari.

Believing ETFs in Hong Kong are going to become as familiar with investors as many other frequently used investment tools, Reid Steadman, S&P Indices global head of ETF licensing, says the level of investor education is increasing and producing positive outcomes.

Equally important, says Steadman, is the need for investors to be clear in their minds about their objectives for using ETFs. 'Investors should think about the degree of risk they feel comfortable with using a non-traditional product structure such as an ETF to exposure to an investment opportunity that would otherwise be difficult to reach,' he says.

'From what we see, ETF sponsors are not shying away from how the products they offer operate, how they function and what might be expected to be achieved,' says Steadman. He says the need for ETF investor education and awareness applies in the same ways as any other type of investment vehicle. 'Investors should know what they are investing in and how investment vehicles perform in different markets,' Steadman says.