Our Future ETF Market (Part 1)

YT Kum, CFA 04 April, 2011 | 0:00
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The number of Exchange Traded Funds (ETFs) in Hong Kong is roughly ten times more than five years ago, but the market remains much smaller than the U.S. one, which has more than 1,100 ETFs available for sale nowadays. ETFs are no stranger to Hong Kong investors, as the debut of the first ETF in Hong Kong – Tracker Fund of Hong Kong (2800.HK), a well-known index tracker ETF mimicking Heng Seng Index – can date back to late 1999. That said, the ETF market’s development had been surprisingly slow until 2007, despite its decade-long history in Hong Kong

The merits of ETFs are nowadays on everyone’s lip. Driven by the strong market demand, more and more ETFs have rushed to the market. However, the development thus far is not healthy, especially when we compare the Hong Kong ETF market with the Singapore one. 

Too Equity-heavy

The ETF universe in Hong Kong is very equity-heavy. Unlike the Hong Kong ETF universe, the Singapore ETF universe, which has roughly the same number of ETFs as Hong Kong, is much more diverse. As of writing, the Singapore ETF market contains 6 fixed income ETFs (only 2 in Hong Kong), 6 money market ETFs (only 1 in Hong Kong) and 6 commodities related ETFS (only 3 in Hong Kong).  

The reasons behind this phenomenon are somewhat simple. Most of Hong Kong investors have been big fans of equities for decades (although commodities have swept some of their hearts since 2006) and so fixed income funds and money market funds are like some weird elements on Mars to them. 

Apparently, this trend has no sign of reverse. The trading volumes of two fixed income ETFs – ABF Hong Kong Bond Index and ABF Pan Asia Bond Index Fund – remain low, despite the ongoing investor education taken place in Hong Kong.  

Home bias also plays a key role here. Hong Kong is one of the best international finance hubs, but Hong Kong retail investors are ironically far from global. Since the launch of Tracker Fund of Hong Kong, there are merely a few non-Hong Kong/China equity ETF offerings could succeed to gain lasting appeals from investors. Their relatively small fund sizes and low average trading volumes attest. Home bias reduces fund companies’ incentives to broaden their product ranges to the non-Hong Kong/China arenas and encourages them to launch more Hong Kong/China equity ETFs such as A-share sector equity ETFs.  

Equity investing is no guilt. However, many Hong Kong investors take it as a trading vehicle rather than a powerful tool of asset allocation. For instance, when western investors discuss about the pros and cons of the core-satellite approach which uses passive investments (such as index tracker ETFs) as core and a few actively managed portfolios as satellites, Hong Kong investors think about how to use ETFs to reap short-term upsides. As a result, limited ETF choices tie investors’ hand to use ETFs intensively for portfolio construction and absence of asset allocation mindset diminish fund companies’ incentive to launch more diverse products. Consequently, the ETF market will probably remain very equity-heavy.  

Not Rounded Enough

Major indexes are not well covered. For example, there are only three ETFs in Hong Kong mimicking US equity index including FTSE RAFI 1000 Strategy Index (an enhanced fundamental Index), NASDAQ-100 and MSCI Total Return Net USA Index. That means, unlike Singapore, major US equity market indexes such as Dow Jones Industrial Average and S&P 500 are not covered here. 

Also, Hong Kong investor can’t invest in anywhere with ETFs. For instance, there is no Australia equity and Latin America equity ETFs available for sale in Hong Kong, despite their growing popularity. Indeed, investors are able to add Latin America equity exposure with actively managed portfolios, but it is definitely a room for the Hong Kong ETF market to improve.

 

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About Author

YT Kum, CFA  YT Kum is a consultant for Morningstar, contributing to manager selection and asset allocation activities in Asia, and is responsible for providing investment thought leadership on topics relevant to investors in Asia.

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