Joseph Ho of Credit Suisse discusses the various regulatory and other challenges which need to be overcome to support further growth of the ETF market in Asia.
Date: Nov 2011
This is coming via enhanced disclosure and transparency, he explained, therefore having an impact on the pace of product innovation and acceptance of new structures.
In terms of the development of the industry more broadly, this might well come from the exchanges, said Ho, in terms of the costs of developing and listing a product.
The Asian market, for example, doesn’t have the benefit of single currency trading as there is in Europe, or a framework which allows products manufactured in one Asian country to be passported to another.
Addressing issues of economies of scale in Asia
According to Ho, the ETF market needs economies of scale to be successful.
Yet because Asia is a collection of different countries, there needs to be a way for issuers to get economies of scale, he said, otherwise they will be limited in terms of what they can bring to the market, given that there tend to be small local investor pools.
Misconceptions about ETFs
While Ho said there are several misconceptions that continue to plague Asian investors, there is as a starting point a general confusion over exchange-traded products. For example, the difference between products in note or fund format, and what this means in terms of counterparty risk from the note issuer.
Another area of doubt relates to secondary trading of ETFs, he explained, especially in Asia where a lot of ETFs don’t get traded in large volumes. As a result, investors are unclear about the role of market-makers, for instance when they quote and why quotes might be wide.
A further issue relates to performance measurement, because terms like tracking error get used, said Ho. However, there are two ways to look at tracking error – first is the layman version which is simply the performance difference between the fund and the benchmark, based on two points in time.
But this might be a little bit of misleading, he added, and a more appropriate way of measuring the tracking error for a product like an ETF could be the measure of the volatility of the daily difference between the fund and the benchmark over a period of time. This means looking at how closely the fund is actually tracking the benchmark.
In addition, said Ho, as ETFs become more widespread, and investors look to use them to invest in overseas markets, there is the issue of trading out of your time zone.
So when buying an ETF in the Asian time zone, for example, but that ETF happens to invest in Europe, when is the best time to buy? And should it even be bought in Asia?
Other do’s and don’ts of ETF investing
As with any investment product, investors need to do their homework, said Ho. But for ETFs in particular, they are hybrid products, he explained, given they have a mutual fund structure yet are listed on an exchange, so are not always as simple to understand as investors think.
For example, when trading a stock, which is a closed-end vehicle, supply and demand factors determine price movements, he said. With an ETF, however, it’s a basket of securities, so investors can calculate the net asset value (NAV) at any point of time.
So when people trade an ETF, the price they pay for it shouldn’t be much different from the inherent value, which is the NAV.
Being an open-ended structure, unlike a stock, ETFs therefore address the imbalance of supply and demand through a different mechanism, not the price movement, because of the ability to create and redeem, said Ho.
And with more specialist ETFs, whether leveraged or short in structure, investors need to be aware of and understand how these work, he added.