Hong Kong goes ETF active but caution remains

Hong Kong goes ETF active but caution remains
By Mark Konyn

Published: September 12 2010 12:28 | Last updated: September 12 2010 12:28

T he mutual fund industry across Asia continues to rebuild confidence following the global financial crisis. The flow of new products in many markets has slowed significantly as investors have remained cautious and fund managers have adapted to more volatile investment conditions and a regulatory environment demanding more disclosure and greater transparency.

The so-called Lehman’s mini-bond scandal that saw individual investors lose money in Singapore and Hong Kong remains a concern for financial product distributors. These distributors, mainly retail banks, need to ensure their frontline staff are well trained on the products they are offering, and put more emphasis on understanding how such products match their clients’ needs.

There was some hope that mutual funds would emerge from the crisis with a competitive advantage over other financial products that are more complex and opaque, but this has not yet been the case as market conditions and investor caution have reduced opportunities.

Keen to establish an advantage over other stock exchanges in Asia, the Hong Kong exchange is looking to encourage the listing of so-called active exchange traded funds, dubbed actively managed listed open-ended funds, or Alofs.

The exchange has amended ETF rules and exempted Alofs from stamp duty when investing outside Hong Kong. The issue of disclosing holdings is another that needs to be negotiated ahead of any Alof launch.

It requires agreement on the approach with the Securities and Futures Commission. Fund managers are hopeful of a compromise requiring them to disclose names but not portfolio weights.

Judging by international reaction to active ETFs, Asia will have an uphill struggle to promote such investment funds. In the US there have been some 14 active ETF launches in the past year and double this number are trading actively, although the amount of money attracted to these funds has been disappointing. The 11 active equity ETFs in the US account for only $100m of assets.

Passively managed ETFs that seek to replicate the performance of a particular index have been available to Asian investors for some time. One of the most successful in the region is the Hong Kong Tracker Fund.

This was launched in the aftermath of the Asian financial crisis and was used to facilitate the disposal of some of the HK$120bn ($15.5bn) worth of stocks acquired by the Hong Kong government during the crisis as it successfully defended the currency peg.

The initial launch size of the Tracker Fund was HK$33bn and the fund’s tap facility allowed the government to return large parts of its stock portfolio to the market. The circumstances surrounding the launch were unique and favourable. Investors were offered both a discount and bonus shares if they held their shares for a specified time.

The stock market at that time was trading well below its peak but had already staged a meaningful recovery from the crisis lows, and the government was able to promote the introduction with a community-wide marketing campaign. Such conditions are unlikely to be repeated for a fund launched by the private sector alone.

Despite the availability of ETFs, private banks and wealth managers have made little use of them. This is more indicative of the way private banks work than of the merits of ETFs, which offer a convenient and low-cost means of investing in international markets.

Wealth managers and private banks typically earn their fees as a charge on transactions rather than in respect of advisory services. As such, a buy-and-hold strategy for an ETF represents a low revenue allocation for the private banker since ETFs do not pay the trail commissions offered by many mutual funds.

The other potential source of new business for ETFs is the region’s retail stockbrokers. Stockbrokers have not proven to be a good source of business for any form of funds in the past in many markets in Asia, in contrast to the situation in Japan or the US.

When the Chinese fund management industry was liberalised in the last decade it was hoped stockbrokers would be influential in helping to channel domestic savings to the stock market. However, as has been the pattern across Asia outside of Japan, retail banks became dominant mutual fund distributors.

Even where ETFs have proven popular in China, they have been repackaged inside mutual funds to allow banks to participate easily rather than provide convenience for clients.

There has been much discussion in the wealth management industry in Asia concerning a shift towards an advisory fee model. Until this becomes a reality it is unlikely ETFs, whether active or passive, will represent a large allocation for the region’s wealthy investors. Mark Konyn is chief executive of RCM Asia Pacific