Who is trading L&I ETFs in Hong Kong?
While the first Hong Kong-listed leveraged and inverse (L&I) exchange-traded funds tracking local markets seem to be building strong traction, asset managers appear unsure what the main drivers of trading activity are. But there is optimism they will prove a major boost for Hong Kong's ETF market, as they did in markets like Japan and South Korea.
Volumes are likely to be coming from a mix of retail, institutional and algorithmic traders, but it will probably be a while before retail appetite really ramps up, say market participants. Meanwhile, questions have been raised about whether the high turnover of some of the new products is entirely the result of genuine investor demand.
Slow retail takeup tipped
L&I funds are designed for short-term trading; typically one day, as the leverage is reset every trading day. As such, they appeal to those looking to take advantage of short-term market movements or mispricings. So whereas tradtional ETFs are likely to be taken up by retail investors, L&I funds may not appeal to that segment.
Alvin Li, chief ETF Strategist at CSOP Asset Management, confirmed: “From day one, you cannot have 100% of turnover from retail investors [in L&I funds]."
David Quah, head of ETFs at Mirae Asset Global Investments in Hong Kong, agreed that ETF issuers would need to continue providing investor education in Hong Kong before they experienced significant inflows from the retail market.
And since institutions are not the quickest off the mark, Li suggested that most investors in CSOP's four Hong Kong-listed L&I funds were trading firms and individuals who are used to trading the warrants market in the territory.
“You will see a lot of investors who try to arbitrage the products linked to the Hang Seng Index [HSI],” said Li. "We have seen some trading firms who seek to arbitrage these products against HSI futures and options, the [State Street Global Advisors] Hong Kong Tracker Fund, listed warrants and callable bull/bear contracts. That is why the turnover is much higher than for non-HSI related ETFs."
Four fund promoters – two Chinese (CSOP Asset Management and China Asset Management) and two Korean (Mirae Asset and Samsung Asset Management) – listed HSI and HSCEI funds on March 14. They have seen big differences in daily turnover, with CSOP emerging as the clear market leader, taking 54% of total turnover on one product (inverse HSI exposure), for example.
But Quah commented: "We are not really surprised about the high liquidity of such products in Hong Kong soon after launch, since the market has been waiting for the launch for some time."
Algorithmic appetite?
CSOP’s Li added that nowadays many independent trading firms and individuals could write their own algorithms and use any local broking firms to trade.
A UK-based investment manager agreed that the high turnover on some funds might be algorithmic trading, “which can often generate high volumes on the tiniest of opportunities”. But he said new L&I funds would not have been "algo-friendly" on day one.
Quah argued that the liquidity was likely coming from proprietary desks executing correlational trading and index arbitrage strategies. "These traders have a thorough understanding of the L&I products’ features," he explained, "as they have traded similar products in other Asian markets such as Japan and Korea."
South Korean asset managers began marketing L&I products in 2010 and have seen them grow to the point where they now account for 65% of the total daily trading volume of Korea’s ETF market.
While the turnover of L&I products in South Korea was initially driven by institutional investors, said Quah, over time there has been substantial retail market uptake. A similar trend has also been noted in Japan, he added.
He concluded that L&I products would be the boost that Hong Kong's ETF market needed. “The Korean ETF market showed exponential growth only after the launch of L&I products, because investors can partake in many strategies through these instruments,” he said.
Stewart Aldcroft, senior fund industry adviser at Citi Markets & Securities Services in Hong Kong, noted that there was quite a lot of interest in L&I funds; more than many in the market expected. "They are very good for hedge and alternative fund managers, punting in Hong Kong," he added, "and also for a few institutions who want late-day market access.”
CSOP’s Li played down the hedge fund activity, suggesting alternative fund managers would probably use the futures market. But he saw L&I funds appealing to long-only asset managers and insurers. "They may not be able to access futures so readily, so if they are looking for a tool to hedge their portfolio, they can use the inverse products."