BlackRock sees growth in ETF demand despite fee compression

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Susan Chan, Head of iShares Asia Pacific, BlackRock

By Emily Lai

The ETF landscape has attracted much attention of late especially after the global financial crisis in 2008, with investors looking at performance with low cost and a change in regulatory regime. APAC ETFs have grown more than fivefold, from $42 billion to $231 billion in the past decade. Susan Chan, Head of iShares Asia Pacific, BlackRock, compares the trend to what the US had been around 12 years ago and how Europe looked like five years ago; and she is confident that the discrepancy means growing demand but pressure would be put on the fee structure.

Why are ETFs getting popular in the region?

One main usage of ETFs after the financial crisis is to diversify away from home biases. Investors now increase their allocation to global markets for alpha, especially when they see the risk related to the bias during the financial crisis. They are also more sophisticated in asset allocation decisions and would move away for yield or outperformance.

The trend is most obvious in Japan, then Australia, and the least in Asia ex-Japan as it is already much diversified. The onshore ETP market has been robust after 2008 in Japan, with the AUM rising from US$25 billion in 2009 to US$ 120 billion to date, given the supportive and accommodative policies from the Bank of Japan. One of the biggest ETF users in the country is the megabanks that have adopted the product at an early stage. Regional banks traditionally look at broad Japanese equity ETFs and are now progressing to international exposures with fixed income ETFs. Insurance companies and asset managers are also turning to ETFs for diversification with operational simplicity and cost effectiveness.

Tightening of global and regional regulations after the financial crisis has also been driving up ETF sales in the recent years. Global regulations including the Volcker Rule and Basel III lead to more expensive capital especially for risky assets in secondary markets; while regional regulations are implemented to impact retirement structures.

One obvious example happens in the fixed income regime. Under the more stringent regulations, bond market liquidity depletes and primary dealers hold less inventory on their balance sheets.  Although primary bond issuance is showing a healthy upward trend, bond inventory at broker dealers plunged significantly from more than US$ 200 billion before 2008 to around US$ 50 billion in 2014. When liquidity drops in the bond market, managers look for ETFs as an alternative.

On a country basis, the Future of Financial Advice (FOFA) rule became mandatory in 2013 and banned commission in relation to the distribution of and advice about a range of retail investment products. The mature retirement program in the country with an AUM of US$ 2 trillion is tapping into the ETF landscape with financial advisors looking for lower costs and simplicity of products given the transparency of fees.

ETF is also attractive with the growth of multi-asset and discretionary offerings as both trends require low cost building blocks to make the models competitive on pricing. ETFs lower the friction of trade with the speed to market so managers can rebalance and reallocate their portfolios in a timely manner at a low cost.

Challenges ahead

Given the favorable environment, Chan believes demand will grow for ETFs and as a total beta house; iShares may take up some market share from active managers. However, it is not without challenges.

She admits that fee compression is a definite trend given new regulations and the rise of technology. Clients are now comparing quality to prices and this would also cause stress on ETF issuers. On the other hand, she is not worried about the increase in supply in ETFs as opportunities still exist in the fragmented market. She sees consolidation happening in the industry and believes they have a lot of room in the growth of market share. BM