Phenomenal growth in ETFs poised to continue

Transparency, liquidity and stability are qualities which epitomise global appeal of funds for investors, writesJohn Cremer

PUBLISHED : Monday, 17 September, 2012, 12:00am
UPDATED : Monday, 17 September, 2012, 8:49am

At a time when other investment products are shadowed by doubt or offering less than stellar returns, the rise in popularity of Exchange Traded Funds (ETFs) ) has been almost unstoppable.

First launched in 1993, more than 3,100 choices are now available, listed on 20-plus exchanges around the world and representing close to US$1.5 trillion in assets. The United States and Europe may have led the way, but investor demand in Asia is catching up fast.

Over the past decade, the compound annualised growth rate for Asia-Pacific ETF assets under management (AUM) stands at 35 per cent. And, with the rate for the five years to July at 23 per cent, reflecting a steady increase in the number of products and providers, the signs still point to substantial new inflows.

"The growth in the global ETF industry has been phenomenal," says Jane Leung, managing director and head of iShares Asia-Pacific, which offers 500-plus funds variously focused on equities, fixed income and commodities. "This is one of the fastest growing and most dynamic sectors in asset management. We expect AUM and trading volumes to increase significantly and are dedicated to capturing those opportunities."

According to Leung, three characteristics explain the appeal of the ETF: transparency, liquidity and stability. Regulated by exchange listing rules and tracking a benchmark index, the product offers ready access to diverse sectors and trading flexibility.

With the choices out there, investors have broad scope to pick and mix. They can select based on anything from geography to theme, underlying asset to risk appetite, and hold long term or rebalance at short notice.

"There is increasing recognition in Asia that ETFs are effective tools to access new markets," Leung says. "In addition, we see investors evolving from viewing China as a broad asset class to becoming more specific in their exposures."

Already, the iShares FTSE A50 China Index ETF is recording turnover of up to US$120 million a day, amid renewed interest in China-themed plays and improving market sentiment. Individuals and institutions are taking a closer look at materials, consumer discretionary, infrastructure and financials, sectors they believe will outperform in the mainland in the medium to long term.

The chance to use renminbi qualified foreign institutional investor (RFQII) quotas for ETFs adds a dimension. Though yet to take off, Leung regards it as further endorsement of the ETF model.

"Any moves which open up access to China for foreign investors are positive developments," she says. "But we also believe that investor education, particularly related to the value of the on-exchange liquidity provided by established A-share funds will ensure people make informed decisions which suit their investment objectives."

Such efforts to educate are continuing and important. They can also pay off handsomely.

For example, an iShares push in Japan, spreading the message about use of ETFs for fixed-income investing, produced strong results. Broader investor understanding of the benefits of diversification has seen greater take-up of emerging market equity funds. In this respect India-specific choices stand out, with low valuations and recent tax clarifications spurring "creation orders" of more than US$200 million for one product in a two-week period in June.

And greater awareness of income-focused options - a result of marketing, investor needs and changing market sentiment - has seen a run of 18 consecutive months, up to June this year, in which global fixed-income ETFs achieved net inflows. This type of investment can provide exposure to high-dividend equities, real estate holdings and preferred stocks. Alternatively, funds may be structured to focus more on investment-grade corporate bonds, promising reliable returns and few concerns.

"Total assets invested in fixed-income exchange traded products now exceed US$300 billion," Leung says. "Flows into [this category] accounted for 41 per cent of all global ETP inflows during the first half of 2012, a 114 per cent increase on the same period last year."

Buoyed by such numbers, she expects the launch of more fixed-income - and other - ETFs aligned with new benchmark indices and targeting different sectors. This will give retail investors access to a wider spectrum of underlying assets around the globe, while continuing to change the way people put together a diversified portfolio.

"Asian investors are increasingly using ETFs in their portfolio strategies," Leung says. "This highlights the tremendous growth opportunities ahead."

An essential first step for the investor is to be clear about risks and objectives. Items for consideration should include index exposure, product quality, performance and protection of assets.

For instance, a China-themed ETF might be built around A-shares, H-shares or a sector such as energy. Sufficient market makers and participating dealers ensure liquidity and ease of trading. And transparency about pricing information, counterparty exposure and domicile give an insight to the overall risk management strategy.

"Investors, both retail and institutional, rightly want industry best practice," Leung says. "We believe that providers who don't meet these standards will continue to face concerns."