Hong Kong ETFs go for broke

Decline in overall money invested comes just as the number of ETFs is taking off, with 22 listed funds in Hong Kong that deal only in A shares

PUBLISHED : Monday, 28 April, 2014, 4:43am
UPDATED : Monday, 28 April, 2014, 4:43am

Hong Kong's exchange traded fund (ETF) industry has problems. It is overwhelmingly concentrated on Hong Kong and mainland stocks, most specifically A shares, with about one new A-share fund hitting the market each month.

As this universe of funds takes off the total volume of money invested in Hong Kong ETFs is declining, largely because Hong Kong and mainland stocks have been such a disappointment to investors in recent years. This means the amount invested per fund has dropped by two-thirds since 2009, according to Deutsche Bank Research. This has made each fund less profitable to operate.

Lyxor, a global ETF giant owned by Societe Generale, quit its Hong Kong ETF programme, axing 12 funds due to low turnover and investor interest. HSBC is delisting its four Hong Kong ETFs in July for the same reasons.

"It's very hard to be break even if you don't own a mega fund. Everyone is trying to do something safe. But if there are 10 funds covering the CSI 300 [index] it's hard to make money because the competition is so fierce," said Jack Wang, head of sales, CSOP Asset Management.

At stake is an industry with over HK$250 billion in invested funds, with almost half of that in A-share ETF funds alone.

ETFs had a moment globally following the 2008-09 credit crisis. Investors that were burned on overly complex, high-fee and high-risk investments embraced ETFs as their antidote. The funds are transparent, low cost, and well regulated. They are easy to sell when things get dicey. They offer access to broad and diverse markets when investors could otherwise only get exposure to such markets through high-fee mutual funds.

Hong Kong investors that lost vast sums on accumulators and mini-bonds and the like embraced ETFs as simple and safe alternatives.

The next big peak came in 2012, when the mainland government opened the renminbi qualified foreign institutional investor (RQFII) scheme. That opened a new batch of ETFs - funds that directly invested in A shares. Previously, Hong Kong ETFs could only "synthetically" link to the A-share market using derivatives.

Many investors saw the RQFII funds as safer, simpler and cheaper. They involve fewer derivative costs such as collateral charges. The RQFII ETFs have grown impressively since launch, while their synthetic counterparts have stayed flat.

The rise of the RQFII funds gave an initial boost to the Hong Kong market, increasing funds managed, but in 2013 money started to go out of the market. Most attribute the decline to the general lethargy of the A-share market, driven by the slowdown in mainland economic growth that took hold last year.

The upshot for the industry has been a decline in overall money invested just as the number of ETFs is taking off. The industry also has a problem of overkill. There are 22 listed funds in Hong Kong that just deal in A shares, with 10 of those launched in the past two years.

"The China ETF market is saturated. A lot have the same underlying index - some are linked to the CSI 300 and some are linked to the FTSE A50 - and they need to differentiate. Hong Kong is the most concentrated [ETF market in the world]," said Kennis Lee, sales manager of Enhanced Investment Products, which manages XIE Shares ETFs.

ETF trading volumes in the first quarter were about half the dollar volume seen in the previous year, according to the Hong Kong exchange, indicating that investor interest is declining for the instrument.

The arrival of the "through train" in six months will only exacerbate the problem. For now, most Hongkongers can only invest in A shares through ETFs. The through train will give investors the highly appealing alternative of owning individual stocks directly.

"The need for such an access product will be reduced," said Jackie Choy, ETF strategist at Morningstar.

ETF providers see that their industry is too dependent on A shares. For example, there is only one ETF in Hong Kong offering exposure to Japanese shares, despite the fact that this was the hottest market globally in 2013.

Fund houses are responding by launching new types of ETFs, such as bonds funds and access to "frontier" markets such as Vietnam, Pakistan and Bangladesh. There is also a growing list of sector funds on offer, such as those offering exposure to energy, infrastructure, utilities and the rest.

However, for the time being, these funds are not well-marketed and trade with little turnover.