Hong Kong exchange traded funds expected to be popular among mainland investors

Mainland Chinese investors may bring new life to Hong Kong’s non-China-related Exchange Traded Funds (ETFs) after the products are included in the stock connect schemes next year, thanks to rising investor demand for asset diversification.

That may change the landscape of the Hong Kong ETF market currently dominated by A-share-related products in terms of turnover and product quantity.

In a note announcing the arrangement for Shenzhen Hong Kong Stock Connect, Hong Kong Exchanges and Clearing said that ETFs would be included in both the Shanghai and Shenzhen stock connect schemes, with the roll out planned in 2017. Few details were provided.

“Everyone is excited. We see providers coming to launch more non-China ETFs. The industry is gearing up for the connect,” Clarence Chan, head of ETF & beta investments in Hong Kong, BMO Global Asset Management, told the Post.

ETFs are passively managed and open-ended funds that are traded like stocks on the stock exchange. They are designed to track the performance of benchmarks, like gold or stock indexes, and have lower management fees than actively managed funds.

Investment group Vanguard slashes fees for Hong Kong-listed ETFs

Mainland investors can gain direct access to domestic funds exposed to China, which makes A-share ETFs in Hong Kong less attractive. But ETFs that track other regions or asset classes, or those that can hedge against currency risks, will be unique for mainlanders, Chan said.

Hong Kong has 178 tradable ETFs, as well as 12 leveraged and inverse products that were all launched this year. However, most of the trading volume goes to a handful of products, including the Tracker Fund of Hong Kong, CSOP FTSE China A50 ETF, iShares FTSE A50 China Index ETF and Hang Seng H-Share Index ETF, according to data from the local exchange. More than a hundred ETFs have almost zero daily turnover.

Charles Lin, head of Greater China at Vanguard Investments, said that “ETF Connect” provides the local market with a new set of investors, and in turn offers them a chance to track foreign market indexes and allocate funds to global assets, rather than single stocks in Hong Kong.

Industry players are eager to know which kinds of products can be included in the connect scheme, given that not many ETFs in the city are sizable or have long track records.

“If regulators require a minimum fund size at, for example, US$50 million, the eligible products will fall into a very small range and it disqualifies many product types,” Chan said.

Of the ETFs offered in Hong Kong, 63 track A-share related benchmarks, the most among regional categories, followed by 12 products tracking China companies listed in Hong Kong, 13 tracking Europe, 12 for Asian markets, nine for Hong Kong stocks, and others for single-country markets such as the US, South Korea, Taiwan, Japan, Singapore, Thailand, Pakistan and Philippines.

The Mainland-Hong Kong Mutual Recognition of Funds scheme requires at least one year of trade record for the funds to qualify for sale across the border. The performance criteria may also apply to the ETF connect, Chan said.

“One or two years of tracking records will be a good indication for investors, although that will eliminate lots of products as well,” he added.

Hong Kong saw several new kinds of ETFs launched this year, including products tracking crude oil futures, leveraged and inverse products tracking South Korea, Japan and US benchmarks, as well as the BMO MSCI Asia Pacific Real Estate ETF—the city’s only fund that tracks the real estate sector. These products will all be excluded under rules requiring a minium of a one-year track record.

In addition, fund managers expressed concern about daily turnover benchmarks.

“It really points out whether regulators see ETFs as funds or stocks...on the industry perspective, you ideally want to bypass the two types and have your own set of criteria,” he said.

Chan wasn’t optimistic that fund houses would lower management fees on ETFs, adding that the fees charged in Hong Kong are expensive when compared to global peers.

“I don’t think cost is a big factor,” Chan said. “If over time there’s enough AUM [assets under management] growth they [fund houses] may consider to adjust fees,” Chan said.

In October, Vanguard, the world’s second largest asset manager, slashed fees for its five ETFs listed in Hong Kong , making them the lowest in the region, citing industry trends in the US and elsewhere towards reducing costs.

Jackie Choy, Morningstar’s director of ETF research for Asia, said the overlap of A-share products may be another problem, asseveral mainland ETFs follow domestic benchmarks.