The Asian ETF industry – Ireland’s opportunity to educate and engage
Having just returned from a whirlwind tour of Asia, where I recently spoke at a series of EY Exchange-Traded Fund (ETF) seminars in Hong Kong, Singapore and Shanghai, I was struck by the excitement levels that surround the ETF industry there. This is a market that all players in the ecosystem want to understand, want a piece of and want to work together in a collegiate manner to grow. It is an industry that wants to develop locally, but is hampered by lack of harmonisation, illiquidity and fragmentation across borders and currencies. It has therefore been forced to develop globally instead.
This is Ireland’s opportunity. But it is imperative that we remain close to developments and plan strategically.
The Asian ETF market (excl. Japan) today stands at US$121bn* AuM, represents a mere 6% of the US ETF market, and only a quarter the size of European ETF market. It is a market that is still its infancy and has significant room for exponential growth. Our expectation is that the Asian ETF industry will grow by 20-25%** over the coming 3-5 years.
With growth rates having reached 29.9% CAGR over the past 10 years, these predictions appear easily achievable.
However, the reality is that these growth rates wildly underestimate Asia’s true potential, both past, present and future. Why is this? Two thirds of all capital flows from Asian investors into ETFs go into European UCITS, European ETFs and US ETFs. This is due to the small size of Asian ETFs and illiquidity of product there, forcing large institutional investors to place money with the larger overseas product, so that they do not breach their internal concentration limits. Ireland, administering over 50% of all European UCITS ETFs, is the largest beneficiary of these outward flows, as the vast majority of capital currently flows in European UCITS ETFs. None of these flows are captured by our anticipated Asian growth rates.
With this bullish anticipated growth, it is easy to see why there is such excitement for the ETF industry in Asia. The commitment to the ETF industry was striking in each of our EY Asian ETF seminars ***, both in terms of the number and profile of attendee and the engagement, energy levels and interaction from the audience. This is clearly an industry that Asia is committed to and excited to be part of.
Why such high growth rate in Asia?
The Asian ETF industry is growing rapidly for all the same fundamental reasons as it is in Europe. ETFs suit current investor trends towards passive, low cost product, where investors now are more informed, tech-savvy and want greater transparency on underlying costs and holdings. We live in an age of transparency, where investing today and finding out the price tomorrow after a net asset value has been struck does not appeal to the impatient, information-hungry and tech-savvy investor. We want to see portfolio pricing and composition, benchmark return against other portfolios, trade at the touch of a button, in between Facebook updates, all as we sit on the train on the way home from work, mobile device in hand.
ETFs are the mega trend of today in Asia for all the same reasons as they are in Europe.
Overlaying this, Asian investors are more active traders and hence are finding the tradability aspect highly appealing. Asia is also on the cusp of a middle class population explosion and the ETF product really suits their needs and wants. Asian wealth levels are, on average, lower than the US and Europe, and this also suits ETFs. A retail investor can invest HK$100 to pay the same fee for this advice as a high net worth investor investing HK$1m – making ETFs the ultimate democratic product.
ETFs are now exerting significant influence over the global asset management industry, where they are now seen as a disruptive force, hence the theme of EY’s global ETF road show – ETFs, a positive force of disruption…..
Our prediction is that ETFs will do for the asset management industry what iTunes did for the music industry…
Difference between countries:
One key theme which stood out in all of our Asian Pacific ETF meetings and events was that each individual market is following its own development path, there is no one size fits all approach in this region.
Market structure changes:
Market structure changes, such as Stock Connect and Mutual Recognition are enabling investment in and distribution across borders, breaking down barriers. The connectivity between mainland China and Hong Kong is perhaps the most exciting structural change – two regulators with aligned goals working together to get the best result for both markets. Mutual Recognition enables the internationalisation of Chinese Asset Managers, looking to distribute overseas. Stock Connect builds on the changing landscape which QFII (2002) and RQFII (2012) initiatives created to enable investment in the China A-shares market. It is widely anticipated that ETFs will be included in Stock Connect. Regulatory approval still has to happen and infrastructure needs to be put in place, however this is only a matter of time.
Slower to progress are the other two pass porting schemes, ASEAN passport and Asia Region Passport, whose success remains to be seen. If they do progress, our view would be that eventually all three will merge, which will help the industry enable effective cross-border access to locally domiciled product.
In parallel with this, UCITS will continue to be the vehicle of choice for international distribution of product.
Confusion over Asian ETF hub:
Regulators in individual countries are also at different stages of education and acceptance of ETFs, resulting in different growth rates and innovation paths.
Unlike Europe, where Ireland is clearly the established ETF hub for European ETFs, administering over 50% of all European ETF assets, it is surprising that there is no widely accepted regional hub for the Asian ETF industry.
The reality is that Asia, like Europe, needs a single international hub to combat liquidity and fragmentation challenges. But where will it be? Let’s review the possibilities.
Japan, the most mature Asian ETF market, is also by far the largest ETF market, standing at c.US$121bnAuM. However, it is dominated by domestic providers. China has grown significantly in the last 12 months, doubled in the past 5 years, and has now overtaken Hong Kong in 2nd position. China again is largely a domestic ETF market. Hong Kong, a market with great potential and dominated by international players, has slipping to third. Korea, another fast growing domestic market, is in 4th position. Korea is known for its nimble regulatory framework and leads in leveraged and inverse ETF products. Next is Australia, also fast growing and recently created a well-timed niche for active ETFs. Taiwan, Singapore, another international market, and Thailand follow. Indonesia is also seen as a key investor market, given the age profile of investors combined with the fact that only 1% of investors hold investment funds there.
Both Singapore and Hong Kong have done well as international/ offshore ETF markets, but we expect the pace of approval of UCITS to slow. Regulators will be slower to approve UCITS and are actively biased towards local product. Globally, Singapore is the fastest growing asset management hub, will it be the ultimate winner for ETFs? The energy levels and commitment observed in the engaged audience at our Hong Kong event, combined with the connectivity between it and mainland China, bolstered by recent regulatory initiatives would make me inclined to put my money on HK. However the truth is, it’s all still to play for currently…
The other impact of so many markets progressing in different directions is that many providers struggle with the question of where to concentrate their efforts. A clear, targeted strategy is critical, and dabblers will not prevail!
The service-provider relationship required by local ETF providers is more akin to a business partner – lots of good advice at the right time. Ireland, within Europe, needs to apply this service model as it remains connected with international and local providers as they look to decide where and how to distribute globally.
Given that Asia is a relatively new market there is still significant room for ETF products tracking core indices. It is commonly cited that 30% of investors today are buying indices which didn’t exist 3 years ago. We can expect to see many more core indices being launched by the global providers as there is certainly an appetite for these from investors. Many investors at our events voiced the lack of product choice as an issue when it came to asset allocation.
Innovation is also a top priority. Inverse and leveraged products gain huge traction with risk-hungry Asian investors. They are also known to invest in real estate to get faster and more leveraged returns, and therefore their appetite for leveraged ETFs is to be expected. They also want to take a position on the downslide of the market, and given the volatility of the emerging markets which surround them, perhaps that is also understandable. Korea, Taiwan and Japan lead the charge in regulatory acceptance of such products. The Securities and Futures Commission (SFC) in Hong Kong is also expected to follow suit, and approve leveraged and inverse products.
Active ETFS are also endorsing exchange traded distribution and showing there is huge appetite for products, particularly in Australia. Smart Beta is also very topical, an asset class which has had proven success in Europe.
Despite this, innovation seems to be more challenging in Asia and the phrase ‘10% innovation, 90% perspiration’ seems quite apt in capturing the effort required to get products to market. There is a need to modernise the settlement cycle, and the fragmented market and multiple currencies with no main trading currency create significant blockers for the industry.
Perhaps the ease of the European distribution landscape and Irish regulatory framework is yet another proposition we could sell to local Asian providers.
Retail penetration a priority
A key priority of the ETF industry is to get retail working. ETF issuers need scale in order to reach minimum size requirements, to enable investment by large institutions and also to sustain their profitability thresholds. From an investor perspective, Asians are living longer and the burgeoning middles class populations are looking forward to and planning for retirement. This requires investment.
Unlike in Europe, regulation to block commission-based trading has yet to happen in Asia. However, the industry is pre-empting this by offering investors that same level of transparency on upfront and underlying costs. This is driving the growth of retail in certain key markets, spreading the message to advised retail investors and proving ETFs to be a very democratic product.
From a government policy perspective, we believe that Hong Kong’s Mandatory Provident Scheme’s Authority’s proposed introduction of a core fund with management fees of 0.75% and 1% respectively, will also prompt more mandatory provident fund providers to offer more low cost options like ETFs in their schemes. This endorsing of ETFs by the HK government is seen as a very positive step, showing that ETFs are a good savings product. In order for retail to significantly take off in Asia, harmonisation of the market is essential. This is enabled in Europe through the European UCITS framework for seamlessly enabling cross-border distribution. Mutual recognition is helping the situation in Asia but should not be regarded as a silver bullet.
Retail uptake varies significantly by market, with Chinese and Korean investors having the highest proportion of retail investors. In Hong Kong, about a third of adult investors hold ETFs, and those who do trade their holdings do so more frequently than the typical equity investor. Retail is key for increasing the liquidity of this highly fragmented market. We often speak of liquidity challenges in Europe, but Asia looks to Europe as a poster child in this regard – one main trading currency, and a central settlement initiative they can only aspire to….
Asia set to embrace digital distribution
The US lead the way in digital distribution, however Asia has most potential according to EYs 2015 global ETF survey. Tech- savvy Asian investors are eager to embrace digital. This has never been clearer to me as I watched in awe (and just a little fear!) as my taxi driver simultaneously mastered 4 iPhones and 1 iPad on his dashboard, all with split screens for multiple apps, as we drove from the airport into Hong Kong …
Currently in Asia, most wealth management services are delivered by banks, with more than 80% of funds sold face-to-face in formal meetings through large institutions. At the same time, buying behaviours are mostly performance-focused, with investors chasing high returns and being advised through personal intermediation.
However, the rate of D2C (direct to customer) platform adoption and the use of mobile technology in Asia suggests that traditional distribution is likely to be disrupted. According to data from US based Forrester Research, 83% of Chinese customers use mobile applications for online banking and 73% use mobile apps to invest online.
Digital technologies such as mobile, social media, analytics and the cloud are rapidly converging on the asset management industry and ETF providers are leading the charge. These technologies are fundamentally shaping client value propositions and operating models of asset managers in the years to come.
The entire World is embracing technology, but the excitement levels in Asia around how digital distribution and Robo-Advisor will transform the industry is remarkable.
Currently the Asian ETF market stands at roughly the same size as the US 10 years ago and Europe 5 years ago. But how long will this gap continue? Our feedback from conversations in Asia shows that, the Asian industry expects when they embrace technology, online platforms, Robo-Advisor, they will leapfrog Europe and US in many aspects.
Ireland’s opportunity to educate and engage
Europe, and Ireland in particular, need to ensure we remain connected with this hugely exciting market, to stay ahead of the curve and educate the Asian ETF industry on our international offering. We also need to enable existing providers and those looking to leverage our experience. The challenges Asia faces are remarkably similar to our own, only we have more experience. We need to be physically present and actively engaged with the industry there. We also need to ensure that we continue to engage with our national and European regulators to educate and protect and enhance our industry. We need to then link with local Asian regulators to understand their proposed priorities and work with them to react nimbly to support the key initiatives. We need to embrace technology, lead the charge in on line distribution and all areas of innovation.
On the whole, we in Ireland need to lead the charge and react to the growth in Asia; the status quo is not an option. When it comes to Asia, no more than the local ETF providers, we in Ireland and Europe need a clear targeted strategy, dabblers will not prevail! We need to think global and act local.
*ETFGI – July 2015
** EYs global ETF survey 2015
*** EY held ETF seminars in Hong Kong, Shanghai and Singapore and later this year will hold seminars in Philippines and Sydney