Asia: Tapping the local ETF listings

The Asian ETF markets are expected to grow at a rapid rate over the next few years, with increasing appetite among institutions. However, education is needed and local markets require greater development as investors continue to buy from abroad. Charlotte Moore reports

 

Over the last decade, ETF markets have grown rapidly in the US and Europe, but Asia has lagged its Western counterparts.

According to BlackRock, the value of ETF assets under management (AUM) in the Asia Pacific region is only $67.9bn compared with $736.3bn in the States and $233.7bn in Europe.

But in 2001, Asia excluding Japan already had primary ETF listings valued at $3.7bn. Europe had equivalent assets of $5.7bn. 

The European market has grown rapidly in recent years. In the last five years, the size of the market has increased by more than six times as investors have embraced the transparency, liquidity and cost efficiency offered by ETFs. 

So what is the shape of the Asian market today and why has it not developed as rapidly as the European market? 

The largest market is Japan. According to BlackRock, it has six providers and AUM valued at $27.3bn. Yet the Japanese ETF market is small given the size of this country’s economy, said Andrew Clark, chief index strategist at Thomson Reuters.

He said: “The poor returns offered by mutual funds relative to the banks and the economic malaise in Japan for the last two decades have worked in tandem to keep money in the Japanese postal savings system and out of investments like ETFs.”

Hong Kong is the second largest market in terms of assets. According to BlackRock, it has eight ETF providers with $22.2bn in AUM. Mainland China is the third largest, with 13 providers and $5.9bn in AUM.

In Japan, the largest provider in terms of AUM is Nomura Asset Management, with $15.1bn in 30 ETFs, representing a 55.3% market share. In Asia, excluding Japan, China AM is the largest provider in terms of average daily turnover with a market share of more than a third. 

 

Buying abroad

But the level of AUM does not paint a true picture of the Asian markets. Marco Montanari, head of ETFs for db x-trackers in Asia, said: “Many Asian investors have been investing in ETFs in the US and Europe rather than in those listed on their local exchanges.”

It is not just ETFs that track the European and US benchmarks that Asian investors are buying in these markets, it is also their own local indices, he said.

Montanari added: “There is a misconception that it is better to trade in ETFs showing high turnover on the exchange while instead the liquidity of an ETF depends on the liquidity of the underlying benchmarks. In Europe, this is already understood and around 70% of the trades are made in the over-the-counter (OTC) market.”

Asian investors are often not aware of the possible tax implications for investing in ETFs listed in the US. “This can give them up to 30% tax disadvantage,” he added.

Deborah Fuhr, global head of ETF research and implementation strategy at BlackRock, agrees. “Asian private banking clients have bought commodity products that are structured as US 1940 Act funds, partnerships, grantor trusts and notes listed in the US, not realising that the product structure may mean that, from a tax and regulatory point of view, these products can be treated very differently for non-US investors.” 

ETFs listed on local Asian exchanges are increasing and most of the overseas providers in Asia have embarked on ambitious education programmes to persuade their clients to invest in their home markets rather than going overseas.

 

Growth challenges

Growth in Asia is trickier than Europe. Axel Lomholt, head of iShares product development at BlackRock, explained: “Even though there are different benchmarks and markets in Europe, the Ucits passport makes cross-listing across the whole region very easy.”

European markets are much more flexible than Asian markets. Clark at Thomson Reuters said: “In China, for example, only those who are Qualified Foreign Institutional Investors can invest in the local market.”

There are only around 100 companies who have received these quotas and they are not that large, so quotas are easily spent if the investor is very focused on the Asian markets, said Fuhr at BlackRock. 

The ETFs listed in the region are increasingly based on benchmarks that are in the local time zone and provide unique access, for example, to China A-shares and India.

Fuhr said: “This is increasing the use of ETFs by both institutional and retail investors in the region.” As a result, liquidity is enhanced as the creation orders can be traded in real time rather than with the pricing delay of an overseas market.

“As Asia becomes wealthier, the number of people in the middle class is growing rapidly,” said Lomholt at iShares. He explained: “At the same time, the personal finance market is evolving, offering the types of products that we have taken for granted in the West, such as life insurance and mutual funds. These factors will drive strong demand for ETFs.” 

Hector McNeil, managing partner of ETF Securities is positive about the outlook for the Asian ETF markets. He said: “I think the Asian markets are currently where the European market was five years ago and where the US market was 10 years ago. The Asians are excellent at improving on tried and tested mechanisms so I think this market could expand more rapidly than it did in either Europe or the US.”

Despite the growth potential of the Asian markets, Joseph Ho, head of ETF marketing and sales at Société Générale Corporate and Investment Banking said ETF providers need to think carefully about how they access the Asian ETF markets.

“Setting up in each individual market and then rolling out local products is expensive and does not make much sense from a budgetary perspective; why have several different teams all duplicating the same work?” he said. 

It might make sense to have teams in different countries once the market has deep liquidity, but at the moment there are not the necessary economies of scale, he added.

Indeed Ho believes it is more commercially viable to cross-list the more generic and lower margin products on the Asian markets that are already listed in either the UK or Europe, and focus local management on higher-margin Asian products.

 

Learning from other markets

There are also lessons that can be learnt from the way ETF markets have developed in the US and Europe, which can be applied to the nascent Asian markets. 

In the US, ETFs are most commonly thought of as a retail product. Their appeal to retail investors is that they are cheap, highly liquid and easy to trade. 

However according to BlackRock, ETFs are being increasingly used by US institutional investors, particularly to implement tactical investment decisions such as gaining quick and easy access to a sudden undervaluation in an asset class. Some institutional investors are also using ETFs for strategic asset allocation.

The reverse is true in Europe, where these products are used more by institutional rather than retail investors. 

In the more developed markets like Hong Kong and Singapore, it is principally institutional investors who are using ETFs, but there is real potential for the retail markets to develop in other countries.

Lomholt at iShares said: “ETFs are currently used by Asian institutional investors who are using them for both strategic and tactical investing.”

Clark at Thomson Reuters predicts over the long term, the two titans of Asia, China and India, will have the most developed markets.

“In China, there is a very strong equity culture. The Chinese government are proceeding very cautiously, gradually opening up the market, step by step,” he said.

“In India, I can imagine that the demand for ETFs from both institutional and retail investors will develop well,” he added.

While interest in Asia is currently equity focused, there is growing appetite for access to other underlying asset classes. Clark said: “The conversations I’ve had show that there is a very large appetite for commodity based ETFs.”

Part of the increased demand for ETFs by institutional investors in the US and Europe has been driven by the rising popularity of multi-asset strategies as a way to boost returns while keeping a lid on risk. ETFs are excellent instruments for these strategies because they are so easy and cheap to use.

Montanari at db x-trackers believes Asian institutional investors will increasingly adopt multi-asset strategies which will further bolster sales of ETFs in this region.

Despite the inherent structural barriers within the Asian market, providers are optimistic about the future and are carrying out extensive education programmes to push demand in these markets. The economic outlook is rosy for Asia, and providers are hoping this will translate into a burgeoning ETF landscape.