By Arisa Siong – The ETF boom is happening and in a big way. The first two months of 2017 saw record global inflows into ETFs to the sum of US$130bn (ETFGI.com) – this is at least double to several times higher than inflows over the same period in the five years preceding. As a comparison, net inflows in 2016 amounted to US$390bn, which was a good year for ETFs but 2017 is shaping up to be even bigger. Most of the fund inflows into ETF stem from investors diverting funds from more-costly- actively managed funds into more-economical- ETF alternatives. The current industry trend is for the lowest cost funds to attract more and more funds. This in turn places downward pressure on management fees charged across the board by both ETFs and mutual funds. Vanguard and Schwab for instance, led the latest round of fee reductions in February.
Faced with increased price pressure and investment churn, mutual funds are forced join the race to zero. A report by JP Morgan and Oliver Wyman predict mutual funds will turn to ETFs to improve investment efficiency, in a bid to lower their costs. In particular, the report notes that ETFs should provide cost savings of 5-8bps for investments in mid to large cap stocks. Somewhat ironically, mutual funds could become the largest investors in ETFs, doubling current assets in ETF in 3-5 years. This is already happening now – Antoine de Saint Vaulry, Head of ETF and Flow Trading at Commerzbank, notes: “we see a blurring of the active-passive asset management divide, with more and more active asset managers using ETFs, to apply their investment strategies”.
In Asia, the ETF scene is still developing and while similar trends can be observed in Asian markets, the relative magnitude means that the impact is somewhat muted. Active fund management is still preferred and this lack of momentum means that there has not been the same pressure on management fees in Asia. Antoine de Saint Vaulry further adds that “the remuneration model for financial advisors in many countries is still not favourable to the development of ETFs, who can’t pay commissions. The markets who abandoned the commission based compensation models have seen massive inflows into ETFs (example Australia)“.
ETFs are also used differently across Asia. The central bank of Japan (BoJ) accounts for 60% of the Japanese ETF market and uses ETFs as a monetary policy tool. BoJ has invested over US$2bn in smart-beta ETFs that are designed to channel funds to companies that are making a positive impact on employment, wages and capital expenditure. Such use of ETFs is unique to Japan and Japan remains by far the largest ETF market in Asia – accounting for over half of AUM in the region. In Taiwan, where the Bureau of Labour Funds (BLF) accounts for 55% of the ETF market, product innovation in ETFs has been rapid – TWSE introduced leveraged and inverse ETFs in 2014, and futures-based ETF in 2015, tracking the price of gold futures. Last October, BLF publicly called for more smart-beta ETFs to complement its existing portfolio of leveraged and inverse ETFs – smart- beta ETFs are now expected imminently on the TWSE.
In Singapore, retail ETF AUM increased by 23% in 2016, with the total number of individual retail ETF holders up by 18% over the same period. This reflects the collective industry’s marketing and education efforts have been effective, though there is still much room for growth. The stats in Singapore exemplify that in Asian markets where institutional investors do not actively invest in ETFs, growth is likely to be significantly slower. It is less obvious where the drivers of innovation in ETFs are likely to come from. Drawing from the Taiwanese and Japanese markets, it would seem that a unified voice from the buy side has significant swaying power and would send the right signals to the ETF providers to create appropriate products. If on the other hand, this is not feasible as demand is naturally fragmented across a multitude of product types, then growth is likely to remain organic and progress somewhat slower.
Some exchanges are making effort to boost volumes however. Will Lawton of Eigencat notes that the Malaysian Securities Commission recently announced initiatives to incentivise issuers and investors to participate in the ETF market segment, broaden investors understanding of the asset class and will enhance facilitation to allow the ETF market to grow. In Singapore, SGX is partnering with Marvelstone to organise ETF Asia Forum (www.etfasiaforum.com) on the 30 March, an industry event meant to stimulate discussion on tapping opportunities to boost ETF growth in Asia. This year’s forum will focus on leveraging on fintech to drive growth.