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HNWIs lap up the new ETFs in town

HNWIs lap up the new ETFs in town

Leveraged and inverse exchange traded funds are set to give traditional ETFs a serious run for their money in Singapore and Hong Kong, bolstered by markets running at all-time highs and rising demand from Asia’s speculative high net worth individuals.

Asia’s wealthy have been dabbling in traditional market-cap weighted ETFs to realise gains similar to their active investments – maybe even more – at lower costs. Traditional ETFs are also seen as good long-term investing tools. Leveraged and inverse products (L&I), on the other hand, are more complex.

While they are linked to underlying indices, they use a mix of borrowed money and financial derivatives to amplify returns – or losses – on indices. While Korea, Taiwan and Japan have traditionally been the flag-bearers for ETFs in Asia, Hong Kong and Singapore have been ramping up their game in the past 18 months.

‘Hong Kong and Singapore changed regulations so L&I products can come to market this year. There are a number of firms wanting to launch these products,’ said Deborah Fuhr, co-founder at research firm ETFGI. ‘Like anything, it takes education. Hong Kong is the biggest market for structured products and they need to understand why they should be using an ETF as opposed to the structured products they have been using for a long time.’

The market is still in its infancy in the region’s major offshore centres. Last year, Hong Kong’s Securities and Futures Commission gave the go-ahead to fund managers to launch L&I products in the city state. In June 2017, the annual daily turnover of L&I products was already at $99 million. In comparison, traditional ETFs had a daily turnover of $625 million. Most of Hong Kong’s L&I products are focused on Hong Kong equities.

Singapore eased its rules in 2016 as well, after the first and only launch of an L&I product in 2009, and is going to unveil new products by year-end, according to Luuk Strijers, head of products (equities and fixed income) at Singapore Exchange.

The stock exchange currently lists 80 ETFs. ‘Asian investors have long-term needs but they also have a clear trading appetite. They like leveraged products,’ he said. However, investors in Singapore need to qualify to trade the products under the Specified Investment Product regime, which is keeping the number of active investors low.

According to Julia Chan, ETF specialist at Mirae Asset Global Investments, inverse products have been particularly popular among private banks and family offices. ‘It serves as a hedge for downside protection from a portfolio management  perspective. If a HNWI is holding heavy weighted index products, to hedge downside risk, instead of selling shares they can consider inverse products.’

The higher turnover of L&I products – the majority of which are held for just a day - also means that there is constant liquidity. That's attractive to investors, Chan said.

The popularity of leveraged products can also be put down to the access they provide. For example, inverse products don’t require investors to hold margin accounts in addition to cash accounts as would be the case for short selling. This is because inverse ETFs use derivatives by the issuers and are treated as cash products. The stock loan fee is incorporated in the ETF price.

‘They are different from ETFs for long-term investing and low-cost passive forms of investing,’ said Jason Hsu, chairman and CIO of Rayliant Global Advisors. ‘They are very much a gambling product from the perspective of an investor. Getting a 2x or 3x leverage may be difficult, so getting that leverage through an embedded structure like an ETF is simpler. So don’t confuse the explosion in those products with the increase in smart beta and passive ETFs,’ he said.

Get smart

In fact, BlackRock, the world’s largest ETF provider, is focusing on growing its smart beta ETF business in the region, choosing to stay away from L&I ETFs. ‘Private banks in the region have bought value ETFs for discretionary portfolios this year,’ said Geir Espeskog, head of iShares Asia Pacific distribution at BlackRock. He explains that the asset manager has seen a steady growth in demand from private banks in the region for smart beta ETFs. For BlackRock, smart beta accounted for $590 million in AUM from Asia Pacific’s private banking clients, with $424 million of inflows in the first six months.

‘Discretionary portfolios are being partially filled by ETFs, in combination with active funds and single stock and bond positions. In Asia, we’ve had some clients come to us and ask for something with less correlation to existing models, and they find smart beta or factor investing interesting,’ said Espeskog.

Smart beta ETFs are a very small market globally compared with their traditional counterparts, and even more so in Asia. According to ETFGI data, there were 194 smart beta products listed in Asia Pacific ex-Japan at the end of June, managing $5.5 billion in assets. The Singapore exchange currently has two smart beta ETFs, which have essentially tweaked the weights given to the components of the underlying indices.

However, their acceptance into portfolios through distributors is set to increase – potentially at the cost of traditional ETFs. ‘Private banks have never been the type to support passive investing. Their job is to help clients create excessive return and
they get compensated better, of course, when they are able to sell more expensive, active high-turnover products,’ Hsu said.

‘Private banks are more willing to look at smart beta because they have an excessive returns driver embedded and that makes it more defensible for private banks to spend time researching and explaining to clients why they should choose this versus that.’


This article appeared in the September issue of the Citywire Asia magazine.

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