Todd James of BSI Bank discusses the current developments, challenges and issues in relation to ETFs in Asia.

Date: Aug 2011

Tags: ETFs, Liquidity, Synthetic, Innovation

• The fact that ETFs are simple and transparent products is a positive thing in difficult investment environments
• The biggest problem for many ETFs being brought to market is that they don’t have the required liquidity – and clients lack understanding of where the underlying liquidity for ETFs comes from
• The current spotlight on synthetic ETFs helps to raise awareness of these products and provide some education for investors to be aware of the issues
• To help drive the growth of ETFs in Asia, James said the underlying volumes need to increase

According to Todd James in an interview, ETFs are being used as somewhat of a replacement for mutual funds within a portfolio.

Since ETFs allow clients to get exposure to different asset classes and regions that might be difficult to do through a mutual fund strategy, they create more flexibility, and lead to a more diversified portfolio, he explained.

James added that he isn’t concerned that ETFs get over-simplified. In fact, he said, that ETFs are simple products to understand and trade is a bonus, and their transparency is a positive thing against difficult investment environments.

Liquidity issues

However, the biggest problem for many of the ETFs being brought to market is that they don’t have the required liquidity, said James. Some of these ETFs are brought from markets like the US or Europe, he explained, and when they have a tranche listed in Asia, even though the parent ETF is liquid, the limited local liquidity makes it unattractive.

A key issue, therefore, is clients’ understanding of where the underlying liquidity for ETFs comes from.

Typically, said James, liquidity for an ETF doesn’t come from the day-to-day trading of the specific ETF, but instead is driven by the underlying physical asset. For example, when investors buy an ETF which invests in physical gold, the liquidity is not related to how many shares are traded during the day, but how much physical gold the ETF provider can purchase.

Better client understanding of this will drive demand and generate further liquidity in the underlying market, said James.

Synthetic ETFs under the spotlight

According to James, the current spotlight on synthetic ETFs is a good thing because it raises awareness of these products and provides some education for investors to be aware of the issues.

It might also control what is being brought to market, he added, rather than there just being an abundance of synthetic product.

In general, James said product providers need to be aware of their need to educate investors about these products in order for them to be successful.

Actively-managed ETFs

In terms of actively-managed ETFs, James said their potential is relatively limited. Since one of the main attractions of ETFs is their simplicity, once structures get a bit more complicated, their acceptance from the investing public will be relatively limited.

However, once clients start to see that what an active ETF does is similar in nature to what a mutual fund does, James said clients will become more accepting over time.

The future of ETFs in Asia

To help drive the growth of ETFs in Asia, James said the underlying volumes need to increase – which he predicted will likely take a relatively long-run bull market to act as a catalyst.

In terms of challenges to the further development of the ETF market in Asia, James said there are too many of these products, which makes it a difficult story to communicate to clients to ensure they understand the most appropriate product to meet their needs.

The market also needs more focused ETFs, he added, with products enabling a more regional investment focus.