Why do ETFs work with traditional fund managers?


Stewart Aldcroft


ETFs, Mutual funds

At a recent fund industry conference I attended, it struck me that one of the most common themes arising in the discussion sessions was the impact of exchange-traded funds (ETFs) on the fund management industry.

Speaker after speaker kept referring to ETFs, with few willing to either criticise them or make negative comments. Whether it was the fund managers or the marketers, the most usual comment was one of an acceptance of the place of ETFs in the Asian markets. This, coming 12 months after the previous conference, where many more were negative in their opinions, demonstrated to me there is a seed-change occurring in the fund industry, in favour of ETFs.

In the past, many observers believed that ETF products and providers were directly in competition with the traditional mutual fund providers. Nothing could be further from the truth.

In reality, both product types sit very comfortably alongside each other in the market. Invariably, the ETF provides for mutual funds an investment solution that could not otherwise be achieved.

What many casual observers fail to realise is that many traditional funds, including those used for the Hong Kong MPF, are active users of ETFs as it gives them a form of market access they couldn’t otherwise achieve.

Typically, what occurs might be that the manager of a traditional fund seeks to make a rapid change of market direction. He can achieve this through buying an ETF of the relevant market, and then selling it down as he might buy his/her selection of individual stocks of the market, in place of the ETF.

Early in 2011 there was much talk of the rapid outflow of money from emerging markets generally, and the Asian markets in particular. Measurement of this had been through the flows in and out of ETFs invested in these markets. Clearly, as they are stock exchange-listed vehicles there is a high degree of transparency about them, allowing such measurement.

Can you imagine what would have happened if these same flows had occurred through the mutual funds of the region? Because mutual funds are designed for longer term investors, there would have been a need for them to sell-off assets rapidly; this would likely have led to even greater negative market conditions, and thus forcing even lower prices.

Subsequently, investors returned to the emerging markets and Asian stocks, often buying quickly to capture what upside there might have been available. Again, the ETFs in the market made this possible without any disruption to normal market action.

The ETF solution clearly allows short-term speculators to buy and sell rapidly within Asian and emerging markets, without impacting the returns for longer-term mutual fund investors. It is this realisation which is powering the rapid inflow of money to ETFs in the last six months. Both institutional and individual investors can use the same product, at the same level of costs (charges) to gain instant access to their selected market(s).