Surge in listings this year
Investors less than impressed with returns elsewhere have been taking a fresh look at the merits of ETFs (exchange-traded funds). Such interest is not a spontaneous reaction to market conditions and unwelcome bulletins about underperforming instruments. Providers and financial advisers are also playing their part, offering new choices on the one hand and refreshing candour on the other about overall prospects and relative fee structures.
'The number of ETFs listed in Hong Kong has increased significantly in 2012,' says Marco Montanari, head of Deutsche Bank ETFs and db-X funds in Asia. 'Among them, we have seen the first linked to Indonesia, Malaysia, Thailand, and the Australian dollar overnight rate. They are interesting because they give access to markets that are more difficult to invest in and give people in Hong Kong the possibility to diversify beyond their local market.'
But with so much to choose from already, Hong Kong investors - retail and institutional - are not simply looking for something new. Scarred by the volatility and losses of recent years, they want better assurance of steady, if unspectacular, returns and to shake off the feeling that results achieved by 'active' management of comparable mutual funds don't justify the level of fees imposed.
With 'passive' management that tracks designated benchmarks and pre-defined indices, ETFs are built to offer transparency and liquidity. With no upfront loading and a lower scale of fees, they offer an obvious attraction for anyone wary of products that seem to do more for the provider than the investor.
'The key advantages of ETFs are in terms of cost and the flexibility of trading intra-day during market hours,' Montanari says. 'They are priced very aggressively with a total expense ratio often lower than 0.7 per cent per annum. However, ETFs are funds and [must] compensate several service providers, such as the custodian, administrator and transfer agent. They ensure the robustness of the structure which is one of the keys to the success of the ETF market.'
Montanari cautions investors to know what they are getting into. This means reading the prospectus, understanding the ETF's correlation to its pre-defined index, and studying the legal documentation before committing.
'We think ETFs represent an efficient solution to invest in emerging markets, even including the more 'difficult' ones such as China, India and Vietnam,' Montanari says. 'And some of the newer [listings] give exposure to Southeast Asian markets that have performed better than Hong Kong in the past five years.'
Ken Wong, equity portfolio strategist for State Street Global Advisors, says the sector is attracting new attention this year, with a surge in listings and inflow of money.
One growing trend sees managers willing to take a more proactive approach for certain funds. The basic principle of shadowing a clearly agreed, externally calculated index remains the same. But that index may be more narrowly defined - perhaps following a subsector rather than a market's top 50 stocks as one classic example. Or it might involve agreeing an index - and then structuring an ETF - based on measures other than stock price
In this respect, Wong mentions the concept of total return funds, built on holdings in companies that consistently pay the best dividends and, therefore, give reliably
'You use a dividend weighting system to determine which companies have been best for [payouts] over the past 20 years and choose based on that, rather than market capitalisation,' Wong says. 'It is too early to say how popular these will be, but there is definitely some interest in the marketplace in this more 'active' type of ETF and they are likely to find more support in the long term.'
In not replicating a well-established index, the newer products are in many ways like a traditional mutual fund. Where they differ is in being listed on an exchange, which makes them subject to pre-listing scrutiny plus the continuing regulatory and disclosure requirements. For investors, this adds to the overall transparency, and the speed and ease of trading.
Noting developments in the United States, where the listing of new ETFs is taking off, Wong
expects the pattern to repeat in Europe and Asia.
'For investors in Hong Kong, the idea of an EFT is still fairly new, so they might be sceptical or not yet comfortable with the notion of a fund that is listed and traded,'
Wong says. 'But it is another opportunity to invest that is well regulated and looks at the underlying liquidity of a market.'