Our Future ETF Market (Part 2)

YT Kum, CFA 15.04.2011
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Our Future

Hong Kong investors never ask for more simply because they have no idea about what they can ask for. For commodities buffs, US investors are able to gain silver and platinum exposure with ETFs (e.g. Global X Silver Miners ETF and First Trust ISE Global Platinum Index). Hong Kong investors may have no idea about that, and thus think SPGD Gold Trust (2840.HK) and Value Gold ETF (3081.HK) are all they can have. Then, what can we have? 

Short ETF (or Inverse ETF/Bear ETF) is gaining popularity recently in the western world. Short ETF allows investors to bet against the market and this is particularly appealing to short-term investors, especially after the 2008’s downdraft. According to finance textbooks, this sort of ETFs can be used as hedging and thus it is quite useful for tactical asset allocation. However, for unsophisticated investors, it is anticipated that this sort of ETFs will be probably used as a short-term trading vehicle.     

Enhanced index is another area with opportunities. Unfortunately, as mentioned, recognized indexes of major developed countries are not well covered in Hong Kong, let alone enhanced index. Enhanced index is a combination of index fund and active management, and, not surprisingly, the cost of enhanced index products is typically cheaper than actively managed portfolios but more expensive than index trackers. By distilling the underlying index with a transparent quantitative screening, or determining the weightings of index constituents using fundamental factors instead of market capitalizations, the resultant enhanced index would be a very different composition with a specific style tilt. LYXOR ETF FTSE RAFI Europe (2806.HK), for example, tracks FTSE RAFI Europe index, which considers fundamental factors including total cash dividends, free cash flow, total sales and book value, when determining index weightings. Some valuation-cautious investors always try to avoid pricy stocks but have no knowledge to select good value portfolio managers. In this case, enhanced index products may be a solution for them. 

Actively managed ETF is a new animal to Hong Kong investors. Comparing actively managed portfolios with passively managed ETFs, we always come to a conclusion that the latter are with lower cost, higher transparency and higher liquidity (or intra-day tradability), but offer no chance of beating the underlying index  (enhanced index ETFs are exceptions). As such, actively managed ETFs are designed for investors who aim at outperforming the market without sacrificing the benefits of ETF investing. Unlike index trackers, actively managed ETFs are managed by portfolio managers and they are managed in a same way as actively managed mutual funds. Outperformance is therefore possible. Indeed, investors shouldn’t expect that the cost of actively managed ETFs to be as low as passively managed products. PIMCO, the largest bond trader around the world, has been aggressive recently in this new arena. Looking forward, more and more actively managed mutual funds are expected to be turned into ETFs, and Hong Kong investors will be able to invest them with lower cost one day. 

In addition to the new types of ETFs mentioned above, we are also pleased to see more typical ETFs to track major indexes such as Dow Jones Industrial Average and S&P 500, and also several sectors such as technology and real estate. Equity-tilt ETF market development is also no good to investors. Investors will benefit if the Hong Kong ETF market extends its reach to more bond funds and alternative investment such a private equity related vehicles.


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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 relevent to investors in Asia.  

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