Liquidity, tracking error key for Asian ETF users

Institutional use of exchange-traded funds in Asia-Pacific may lag well behind that in the US, but it is evolving along similar lines, according to a survey* from Greenwich Associates and State Street Global Advisors (SSgA).

Asian institutional investors still do much, probably most, of their buying of ETFs offshore, usually of US-listed funds; in fact, four in 10 buy exclusively on foreign exchanges. That is not surprising, since the greatest ETF liquidity and trading volumes – as well as the widest range of products – are to be found in North America, above all on the New York Stock Exchange.

The Tokyo Stock Exchange boasts the biggest exchange-traded product AUM in Asia, with $44.5 billion, one 50th of the NYSE’s $1.2 trillion. That said, Korea Exchange is more liquid in terms of annualised trading volume than the NYSE.

However, the US market is far deeper than that in Asia-Pacific, with the top 10 ETPs on the NYSE accounting for 38% of the bourse's total ETP AUM, while the 10 biggest ETPs on the TSE account for 97% of assets.

Asked what the most important criteria are when selecting an ETF provider or product, 85% of respondents rated liquidity/trading volume as ‘extremely important’. Tracking error was ranked second with 61% gaining the same rating, while expense ratio was third (53%).

What do not rank so highly are track record (44%) or breadth of offering (43%), notes Frank Henze, Asia-Pacific head of ETFs at SSgA in Hong Kong. Seen as even less important are the fund company and the team behind the funds (13%).

“ETF buying [in Asia] is still an anonymous activity; clients don’t go for advice or info to the issuer by default, they look for other sources,” notes Henze. “That is unusual in the funds space.”

Kevin Quigg, global head of SPDR ETF strategy and consulting at SSgA, adds: “It seems those things that are explicit in terms of the value they provide – like liquidity, tracking error and cost – rise to the top [of the list of driving factors] and those that are implicit – where it’s difficult to quantify the value – fall to the bottom.”

As for applications of ETFs, the findings differ widely between Asian and US institutions, with the former – again, not surprisingly – having not reached the same level of sophistication of usage as the latter.

The most common purpose for using exchange-traded products among Asia ex-Japan users is for core/satellite portfolio allocation, with 66% citing it. Portfolio completion (47%) ranked second, with hedging/risk management (38%) coming third. Among US users, however, there is considerably higher usage of ETFs for applications such as tactical adjustments, rebalancing and transitions.

“In the US, institutions certainly use ETFs to invest, but where they differentiate themselves is in their additional use of ETFs as investment tools,” says Quigg. “A lot of those applications that have less to do with the ‘F’ and more to do with the ‘ET’ are what will drive the market, as they have proven to be effective tools for institutions to address many of the challenges they face.

“Things like transition management, fixed-income credit and/or duration adjustment are the 2.0 applications that presuppose a comfort and understanding of the product structure in order to deploy it in an effective way,” he says.

Usage is expected to map the development of the market in the US, notes Quigg.

The future looks bright for market growth as well. Some four in 10 asset managers and distributors in the survey expect to raise their use of ETPs in the coming years, while 46% will retain their current allocations. Only 13% of institutions say they will reduce ETP exposure.

Some institutions say they would like to see more liquid Asian and domestic equity ETPs, and others want access to a wider array of sector-specific global funds. Yet the driver of demand is more likely to be improved sell-side support for existing offerings, notes the survey.

Last but not least, education will remain important. Around one-third of asset managers, distributors and proprietary traders in the ETP study are interested in learning more from providers about how best to employ ETPs, in areas such as hedging/risk management, core/satellite models, ETP overlays/liquidity sleeves, transitions and rebalancing.

SSgA is the second biggest ETF provider in the world by AUM, with $300 billion in assets, and the biggest in Asia-Pacific ($13.2 billion).

* East Meets West: Institutional Uses of ETFs, a Greenwich Associates study commissioned by SSgA, was conducted during June and July. Greenwich interviewed 58 asset managers and proprietary traders in Japan, and 65 institutional investors and distributors in Asia ex-Japan.