Pedestrian pace: Japan’s ETF market finds itself at a crossroads in trying to increase demand © Noriko Hayashi/Bloomberg
While regulators in the US fret that the pace of growth in the exchange traded fund market may be too explosive, their counterparts in Asia along with asset managers and distributors sweat over what more can be done to raise investor interest.
As US ETF assets under management passed the $3tn mark this summer, AUM in the Asia-Pacific industry just managed to creep over $350bn.
Between 2015 and 2016, the US market grew by 20 per cent, while the Asian market increased by just 10 per cent. There are two ways to look at the relatively modest size of the Asian ETF market compared with both the US and Europe — which is twice as big as Asia, with $716bn in ETF assets — say analysts.
The first is to view Asia as a market that has proved resistant to rapid development and will require significant structural and regulatory change before taking off. The second sees the possibility of sudden upside surprise.
One difficulty in assessing the potential for ETFs in Asia, say experts at the largest asset management houses, is both the disproportionate size of the Japanese market within the region and the role played by the Bank of Japan, which distorts the market as it buys ¥6tn ($54bn) of ETFs a year.
With assets under management of $200bn, according to Nomura Securities, Japan’s ETF market is about $50bn larger than all other Asia-Pacific ETF markets put together. At the end of August, the market value of the BOJ’s ETF holdings was $175bn.
Through an ETF buying programme that has been criticised by some as the “de facto nationalisation” of the Japanese stock market, the central bank indirectly holds a 10 per cent stake in some 22 large Japanese companies and about 3 per cent of the whole Japanese stock market.
Meanwhile, there are other factors holding back the Asian ETF market that some sceptics fear will hold back development of the retail side.
There are, for example, clear differences in the way the products are pitched to investors in the US and Asia. A high proportion — some estimate 90 per cent — of funds in Asia are commission-based. This disadvantages ETFs because they are openly traded on stock exchanges and are not structured to pay commissions to banks, brokerages or financial advisers that might recommend them, unlike the mutual fund industry in the region.
A vibrant ETF market would depend on the evolution of fee-based distribution networks. Mark Talbot, managing director of Asia-Pacific at Fidelity International, says the distribution infrastructure is holding back retail demand.
“Where ETFs have grown — in the US and Europe — there is a big ecosystem of financial advisers,” he says. “You need a more advisory model. But until you see people paying for advice rather than paying for commissions, it is hard to see when it will take off.”
In the US, he adds, ETFs emerged into a market where there were lots of registered investment advisers incentivised to use lower-cost products for their clients.
Mr Talbot notes that regulators in Japan are encouraging fee-based sales with a new fiduciary code and other measures that will play to the low-cost appeal of ETFs.
Regulators in other countries will draw lessons from the success or failure of the Japanese model.
Things in Asia do have a habit of moving faster than we think
Elsewhere, Australia recently introduced reforms that have increased transparency around fund pricing, which has driven rapid growth in ETFs.
Marco Montanari, the head of passive asset management for Asia-Pacific at Deutsche AM, agrees that fundamental changes to distribution must be made before the Asian ETF market can move to the next level.
“Australia stands out as a market that boomed when reform allowed it to switch from a commission-based model to a fee-based one,” says Mr Montanari. “This would be a game changer in Asia.”
Susan Chan, head of iShares Asia-Pacific at BlackRock, says ETFs are more popular among institutional investors in the region.
The retail side, she says, “is nascent and a mixed bag”. All countries in the region have a lot of work to do, she says, adding the Australian example has proven that regulatory changes can make a significant difference to generating pockets of interest.
“All the regulatory bodies are looking to do this and more transparency is always welcome. But whether they get there is different,” she says. “Regulators talk about more transparency and lower fees but very little in terms of law.”
Even if Asian countries introduced regulation similar to that of thriving ETF markets elsewhere in the world, there are other hurdles. Mr Montanari says, for example, that most products presented to Asian investors relate to equities in their domestic market so the ETFs are not being used to give investors local exposure to foreign markets.
Yan Pu, head of portfolio review in Asia at Vanguard, suspects the Asian product mix may be holding things back. For example, Asian providers offer plenty of equity ETFs but very few fixed income products. In the US, she notes, fixed income ETFs are growing rapidly.
She argues, however, that the problems with lower liquidity of ETFs in Asia are a symptom of a fund distribution system that fails to incentivise ETF sales by intermediaries. “I don’t think there is a quick fix, but you would see a pick-up if Asia moves to a fee-based model,” she says.
The companies that have tried — and so far failed — to create a sustained ETF boom in Asia say the need for wholesale reform suggests the market will be defined by a protracted effort to convince both the regulators and customers to redraw the scenery.
But that may be overly pessimistic, says Mr Talbot. “Things in Asia do have a habit of moving faster than we think,” he says.
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