HONG KONG -- Cheaper, quicker to trade and easier to understand. That's the appeal of exchange-traded funds in a nutshell as compared with mutual funds. Combined with advances in data and self-directed investing, they are forcing traditional fund groups in Asia to introduce products that in effect compete with their existing ones.
But the problem with these so-called passive funds is that fund managers need high volumes to compensate for the low management fees collected. Even the largest ETF groups, such as Blackrock's iShares business, which has a 30% market share in Asia, is cutting back its product range to reduce running costs.
There is little doubt that in the long term, this is a market that will thrive once electronic trading and automated financial advice become fully effective as distribution channels, especially in north Asia, where mobile phone transaction platforms are already well advanced. Some estimate that Japan alone could see inflows over $50 billion over the next few years.
"You want to issue product which is either in vogue or where there's an immediate demand," said Tobias Bland, chief executive of Hong Kong ETF provider Enhanced Investment Products. The company recently delisted some of its ETFs in Hong Kong because of poor take-up by investors. But he remains hopeful for those providers that hit upon the right ideas, citing a U.S. ETF that covers shares of robotics companies which raised $1.4 billion in just three months.
The number of ETFs listed in Asia has doubled in the last three years, while total assets in the region have grown 33% to more than $130 billion. In 2016 alone, the region's ETF assets grew a net 20%. Just on Tuesday, two Chinese and two South Korean fund managers each listed four new ETFs in Hong Kong.
The most popular regional markets for ETFs are Japan, mainland China, Hong Kong, Taiwan, South Korea and Australia. The largest ETFs in the region, at $16.5 billion and $8.6 billion respectively, are Japanese equity funds managed by iShares and WisdomTree, another U.S.-based manager. ETFs in Japan have enjoyed a boost in volumes from the Bank of Japan, which has bought up some 60% of ETF shares available in the local market.
Asian retail fund buyers are expected to eventually follow the trend seen in the U.S. and Europe, with a significant shift toward low-cost passive investment. But while the market is growing fast in Asia, it is not fast enough to keep all available products on the shelf. Retail buying tends to be focused on single-country ETFs tracking benchmark stock indexes, especially for China, India, South Korea and Taiwan, with only marginal demand for global exposure and investment outside of the region.
On Feb. 24, iShares delisted seven of its 22 Hong Kong listed ETFs because of insufficient demand. Enhanced Investment Products closed all its Asian single country ETFs bar one in December because of low volumes and high operating costs.
The ETF market in Asia is still in its infancy, which forces companies to compete either on innovative products, which might meet with limited demand, or on price. Competition in the Asian ETF space has intensified in the last few months, with fees cut to the bone in some cases. Last year, iShares launched a new range in Hong Kong with fees set at 0.2% of invested assets on average, half the level of its previous line. In December, Hong Kong-based Value Partners cut the management fee on its Gold ETF to zero in what looks to be a temporary move to grab attention. William Chow, managing director of the firm's ETF business, says it is too early to tell if such drastic measures to capture market share have been successful.
In this low-fee environment, Jesper Koll, chief executive of ETF specialist WisdomTree Japan said, "You will always cannibalize your business if you are selling an alternative product that has mass appeal at a cheaper price."
Nonetheless, fund groups that have traditionally been strong only in mutual funds, like Franklin Templeton, are now engaging in the struggle for market share by launching ETFs that compete with their own active funds. Templeton launched so-called active ETFs in the U.S. last October and is planning to list these in Asia in due course as part of a global roll-out.
Jessica Cutrera runs Capital Company, a Hong Kong private client firm that uses ETFs extensively in its portfolio management. Her view is that if a fund group has both active and passive products and is not delivering as an active manager, "they are not going to survive."
Even the bigger ETF players like iShares, which offers both active and passive funds, should worry about the balance of their revenues shifting to low-fee products. Geir Espeskog, head of iShares for Asia outside Japan, agrees that large fund houses like his cannot afford to be complacent. "Funds that do not offer real... outperformance will increasingly be replaced by index exposures," he said.
Local bank distributors such as HSBC and UBS have also taken defensive measures by creating their own ETFs, rather than have those private client investments go out the door to State Street Global Advisors, BlackRock and Vanguard Group, the other major U.S. index fund manager. The banks do not generally promote these ETFs, Cutrera said, because they make much more money on their active funds.
ETFs offer market exposure in real time at often one-tenth of the cost, putting mutual fund performance under greater scrutiny. It's not a pretty picture. S&P Global research shows at least 70% of active managers will underperform their benchmark over the course of a year. Over longer stretches, the numbers are worse.
Despite these stats, fund groups still charge annual management fees of 3%-5%, often with ancillary administrative costs. ETFs, by contrast, charge around 0.3%-0.5%.
In the short term, most Asian retail markets face the hurdle that ETFs don't pay commission to distributors in a region where the classic distribution model is fully incentivized to sell high-fee funds. But in this low returns world, investors are becoming more fee-conscious. ETF managers are hoping that investors realize that if the cost of investment goes down to 0.5%, that's already a head start of roughly 4.5% on performance compared to a mutual fund.
Ultimately, ETF providers hope the increasing interest of mainland investors in foreign assets will offer Hong Kong-listed ETFs a big growth opportunity and help the market to evolve. Demand from pension funds and insurance companies will also aid the market's long term sustainability.
ETF research consultancy ETFGI predicts that ETFs will be the dominant fund structure globally by 2030. The development of regular and contractual savings products will drive retail market growth across Asia. WisdomTree's Koll says that retirement savings programs like Japan's new Nippon Individual Savings Account will bring about a major shift.
"It's fair to say if you had a similar type of structure in the U.S., you would find probably 60%-70% of the money invested in ETFs," he said. "That's another $50 billion that could potentially flow into the local ETF market."