Deutsche defends synthetic ETFs in latest product launch

Deutsche Bank has launched four new exchange-traded funds (ETFs) on the Singapore Stock Exchange, including the first to be linked to Pakistan and Bangladesh.

The MSCI Pakistan Investable Market Index and the MSCI Bangladesh Investable Market Index track the performance of their underlying indices via swaps in what is known as synthetic replication.

This is common to all ETFs offered by db x-trackers, the German bank’s ETF unit. It means db x-trackers buys swaps from Deutsche Bank to provide the returns of the index being tracked.

But synthetic replication has proved controversial owing to the potential for counterparty risk, and in September tighter collateral rules were introduced, making them potentially trickier and more costly to manage. (See AsianInvestor magazine, October 2011, pages 34-35.)

Marco Montanari, Asia head of Deutsche Bank’s ETF platform, stresses that Deutsche Bank’s ETFs are 100% collateralised on a daily basis and that the collateral can be viewed online, as required.

He also notes that more than 60% of ETFs listed in both Hong Kong and Singapore are synthetic, and that while ETF trading turnover in Hong Kong is largely in line with last year, in Singapore it has nearly doubled.

Asked why Deutsche elected to list its ETFs in Singapore, Montanari points to the convenience of trading during the same timezone in order to compare the ETF price to the underlying index.

“Secondly because we have really important plans for our Asian ETF business,” he adds. “We really want to expand this market, so we don’t by definition give priority to Frankfurt or London.”

It is also true that the regulator in Singapore has in the past been more open than Hong Kong to approving synthetic products. That said, a new regulatory framework for the funds industry in the Lion City is unlikely to make the situation any easier for product issuers or sellers there, market participants agree.

Montanari also points out that research Deutsche published last year shows synthetic ETFs in general generate low tracking error compared with physically backed products.

He does concede that frontier markets ­– such as Pakistan and Bangladesh – are more difficult to track. “One of the reasons we are the first is that it is very challenging in terms of structuring. It took several months to create these products, because you need market access and risk management.”

Db x-trackers now offers its clients exposure to three of Asia’s six frontier markets and Montanari confirms that he and his team are looking at Cambodia, Mongolia and Sri Lanka, too. “We have no concrete plans but we think there will be demand in the future,” he says.

As evidence of the growing popularity of frontiers, he notes that before 2010 the vast majority of single country emerging market ETFs concentrated on the Brics (Brazil, Russia, India and China). But last year flows for single country EM ETFs (ex-Bric) increased to $4.3 billion, versus $4.8 billion for Brics.

In terms of the types of client Deutsche is targeting with its new products, they are fund of fund managers with exposure to Asian frontier markets; high-net-worth individuals; and hedge funds.

Montanari says that institutional investors are really only interested in large, regional ETFs, while low distribution fees make the retail segment hard to reach, estimating that 15-20% of all db x-trackers ETFs are held by retail clients.

In terms of target AUM, Deutsche is aiming for its latest frontier products to match its Vietnam-linked ETF, which was launched three years ago and now boasts $270 million.

A year-and-a-half ago it also launched an ETF linked to Indonesia, which has garnered $140 million. This product, he notes, did not trade a single dollar in its first two weeks.

“Even if our new products do not trade for three weeks, we are not worried because it is a long-term investment and I think being first is important,” says Montanari.

The two other products db x-trackers has just launched in Singapore to complete its product range were the MSCI Singapore Investable Market Index and the MSCI Asia-Pacific Ex-Japan Index.

In total db x-trackers now has 47 ETFs listed in Singapore (out of a total of 88 for the exchange) and 24 in Hong Kong (77).

Montanari says the firm has several ETFs in the pipeline in Hong Kong and will look to issue more over the next several months.

He is reticent to outline detailed plans other than to say Deutsche is eager to strike a balance between local-flavour equity ETFs and other asset classes. Records show that db x-trackers has 135 equities ETFs and just 35 fixed income ETFs, so the inference would be more fixed income products.