Why You Should Be Buying More ETFs – and Why You Are Not

 

Stewart AldcroftBy Stewart Aldcroft

Any industry that can grow from zero to more than US$2.7 trillion in 20 years must be doing something right! That same industry is also “knocking the spots off” its competition when measured by both annual net sales as well as returns to investors. Yet in Asia there has been little or no appetite shown by individual investors, when compared to those in the United States or Europe. Indeed, Asia represents less than 1% of the global total.

I’m talking about Exchange Traded Funds – ETFs.

ETFs operate in a similar fashion to mutual funds and unit trusts, in that they provide investment returns based on a set benchmark, typically a country or a sector index. As such they are more ‘passive’ than a mutual fund. As an investor, you are saying you think a particular market (say, India) is going to go up and so you buy an ETF tied to the Sensex index.

A big difference is that ETFs are traded on stock markets and generally have lower fees than mutual funds. In normal circumstances you would think that to be a recipe for great success, but in the complicated world of personal investing in Asia, this has not so far been the case. Why?

ETFs are regarded with suspicion by some because they are a newer product. The great success the Hong Kong Government had in launching The Tracker Fund (Asia’s first ETF) in 1999, with more than 300,000 individuals applying to buy on day one, was not repeated. It is often thought that most of those that bought didn’t realize they were in fact buying an ETF! Since then, the ETF promoters (typically the larger banks) have introduced a range of other ETFs, but these have mostly been bought by institutional investors. So if they are good enough for the big guys, why doesn’t the private investor use them?

The biggest stumbling block comes at the advice level. Financial advisers and wealth managers need to be paid for their work. Typically that payment comes from commission earned on the sale of a fund or an insurance-linked investment. ETFs may be cheap to buy, but that is part of the problem. Apart from the cost of a trade on the stock exchange, there are no commissions paid on ETFs, thus they have tended to be overlooked by advisers.

In both the US and Europe, advisers are increasingly looking to earn management fees from the aggregate value of the client portfolios they provide advice on. In this way, they have no need to raise a commission on each sale, so they can advise more freely based on the suitability of the product, rather than the commission that it will earn them. As a result, they have shown far more interest in selling ETFs.

Regarding education, I have always believed that in the Asian marketplace, most people wait to find out and inform themselves about something only at the last minute. No-one buys a guidebook to mobile phones and spends weeks studying this before buying the product. They get to use the phone immediately they get out of the store. Why should buying funds and especially ETFs be any different? What the investor needs to do is go out and buy a few thousand dollars-worth of any ETF. You will soon start to learn how it works, what it does, how much it is worth, where it is listed, who manages it, etc. If you like what you see, buy some more.

No Incentive

 And then there is the issue of commission for advice. In my view, if securities brokers were to be paid a fee of say 0.50% for each ETF trade, rather than the current 0.15% or less, they would very soon look to sell more ETFs. Money talks, especially when you are earning it.

And also, why is there so little choice of local product? Not products linked to the major Hong Kong or China indices, but product that only uses local Financial, Property, Manufacturing or Leisure Industries sectors, listed in Hong Kong. Elsewhere, it is the locally invested sector ETFs that have proven popular with individual investors, who think they can identify the next popular trend in the market. Currently they are just not available in Hong Kong or Singapore.

ETFs still have a lot of work to do to become more popular with investors in Asia. But they are not going to go away either. Used within a portfolio that also has mutual funds, they can be very effective in providing returns, and are cheap way of making tactical shifts in your portfolio.

BM