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This article first appeared in Personal Wealth, The Edge Malaysia Weekly on December 30, 2019 - January 5, 2020

Exchange-traded funds (ETFs) have sustained their growth over the past decade. Supported by a well-developed ecosystem, these instruments are popular because they provide investors with easy accessibility, low-cost diversification and trading opportunities. The asset class is expected to continue playing an important role in investment portfolios, say industry players.

David Quah, managing director of quantitative investment solutions at Value Partners Asset Management Malaysia Sdn Bhd, says it had taken more than 15 years for the assets under management (AUM) of ETFs globally to reach US$1 trillion in 2010 since the launch of the first ETF — SPDR S&P 500 ETF — in 1993.

The market has grown five times since. As at July, the AUM of ETFs globally reached US$5.48 trillion, representing a compound annual growth rate (CAGR) of about 20% from 2005. According to Morningstar data, the average 10-year annualised return of ETFs tracking the MSCI World Index was 9.12% as at Nov 30.

Quah says many factors have led to the popularity of this asset class. One key factor is its increased use in retirement portfolios. In many markets like the US, retail investors are putting their retirement savings in ETFs due to the fact that these low-cost products provide exposure to a variety of asset classes.

“Investors can choose riskier or more conservative products in many different markets, with or without the help of financial advisers, who are gradually moving towards a fee-based model. These advisers do not receive commissions for selling financial products. So, they do not avoid recommending products such as ETFs,” says Quah.

Jackie Choy, Morningstar director of ETF research for Asia, says the move towards fee-based advice has spurred the demand for lower-cost options such as ETFs and innovations like robo-advisory platforms. “In some markets, especially in Asia, the move towards a fee-based model is still slow. So, ETF growth may have lagged when compared with markets like the US and Europe. The Asian markets are fragmented, so it will be a gradual process.”

Apart from the boost provided by robo-advisors such as Robinhood and Betterment, the growth of the ETF market is also attributed to the moves made by large financial institutions such as Vanguard, Fidelity and JP Morgan, which are offering their own versions of digital investment services, says Khairi Shahrin Arief Baki, CEO of i-VCAP Management Sdn Bhd.

Aiming to provide a full suite of services, these companies offer users investment portfolios that comprise their own ETFs, he adds. “By offering this service, the companies can lower their brokerage fees. Some have even waived the fee altogether.”

Vanguard launched its hybrid service — Vanguard Personal Advisor Services — in 2015 to provide clients with both algorithmic and human investment advice. Fidelity set up its Fidelity Go platform in 2016. When it was launched, the company required a minimum investment amount of US$5,000. But it reduced this to US$10 in 2018 to attract more novice investors. JP Morgan launched its digital investing service, called You Invest Portfolios, in July after years of development.

In Malaysia, there are currently three licensed and fully operational robo-advisors — StashAway, MyTheo and Wahed Invest. StashAway began offering its services to local investors in November last year. MyTheo started operations on July 1 while Wahed Invest was officially launched on Oct 30.

“It is still early days for these robo-advisory services, but we think there should be an increase in participation among retail investors, thanks to their presence. We have even seen higher take-up of our ETFs because Wahed Invest’s portfolio includes our MyETF Dow Jones US Titans 50 and MyETF MSCI Malaysia Islamic Dividend,” says Khairi.

The past decade has also seen improvements to the regulations of the ETF market, says Choy. In the US, the Securities and Exchange Commission announced on Sept 26 that it had adopted a new rule to modernise the regulation of ETFs by establishing a clear and consistent framework. According to its press statement, the adoption would facilitate greater competition and innovation in the marketplace, leading to more choices for investors.

One of the more notable events that triggered the need for better regulations would be the 2010 Flash Crash. On May 6 of that year, stock indices such as the S&P 500, Dow Jones Industrial Average and Nasdaq Composite collapsed and rebounded rapidly. The prices of ETFs, stocks, stock index futures and options became volatile, causing trading volumes to spike.

Following this incident, regulations were put in place to safeguard investors. However, according to news reports, the measures proved to be inadequate as the prices of many ETFs deviated from their underlying value in a flash crash that took place on Aug 24, 2015.


Global growth

The Securities Commission Malaysia (SC) issued its guidelines on ETFs on June 11, 2009. Close to a decade later, on Nov 26, 2018, it revised these to allow the issuance of a wider range of products in the market. These included futures-based ETFs, synthetic ETFs, physical commodity ETFs and smart beta ETFs.

The local ETF market is still very small compared with those of its neighbours. There are only 15 ETFs in the market currently, comprising equity, fixed-income, shariah-compliant equity, leveraged, inverse and commodity-backed ETFs.

The ABF Malaysia Bond Index was the first local ETF to be listed by AmFunds Management Bhd (AmInvest) on Bursa Malaysia in July 2005. Two years later, it listed the FTSE Bursa Malaysia KLCI ETF — the first equity ETF in Malaysia. The first shariah-compliant equity ETF, MyETF Dow Jones Islamic Market Malaysia Titans 25, was launched in January 2008 by i-VCAP.

The country’s only shariah-compliant commodity-backed ETF — TradePlus Shariah Gold Tracker — was listed on Bursa on Dec 6, 2017, by Affin Hwang Asset Management Bhd. This year, the fund house introduced two leveraged and two inverse ETFs, namely TradePlus NYSE FANG+ Daily (2x) Leveraged Tracker, TradePlus NYSE FANG+ Daily (-1x) Inverse Tracker, TradePlus HSCEI Daily (2x) Leveraged Tracker and TradePlus HSCEI Daily (-1) Inverse Tracker.

According to Morningstar data, the average annualised year-to-date, 1-year, 3-year, 5-year and 10-year returns of the local ETFs were 4.57%, 3.76%, 4.81%, -1.71% and 2.1% respectively as at Nov 30.

Malaysia is still lagging behind many other markets despite having a long presence, says Quah. “Hong Kong, for instance, launched its first ETF in 1999 — the first ETF to be launched in Asia ex-Japan. In 2005, it launched the first income ETF. The first gold ETF was launched in 2008 while the first RMB Qualified Foreign Institutional Investor (RQFII) A-share ETF was launched in 2012. The first futures-based ETF was launched in 2015 and the following year, the market welcomed its first leveraged and inverse ETFs.”

The Singapore market, despite being larger than Malaysia’, is quite small by the region’s standard, he says. The city state saw its first ETF in 2002 and first gold ETF in 2006. Three years later, the first inverse ETF (Luxembourg domiciled) was launched. As at Dec 12, the market had 51 ETFs. The AUM of ETFs in Singapore were only 0.4% of the global market, even smaller than India’s 2.8%, he adds.

Citing recent statistics, Quah says the US still dominates the global ETF market. As at Aug 22, the AUM of ETFs in the US were 69% of the global market, followed by the UK at 7.7%.

“What is interesting is that in terms of AUM, Asia is not that far off. In fact, it actually has a fair market share. Japan is the third biggest market in the world by AUM at 6.1%, slightly behind the UK. Mainland China, Taiwan and Hong Kong make up four of the top 10 largest ETF markets in terms of AUM,” he says.

The US market dominates in terms of turnover as well, says Quah. As at Sept 30, the top four exchanges were the Nasdaq, New York Stock Exchange, Bats Global Markets and CBOE Global Markets. “That said, Asian markets can still be seen as liquid. The top 10 exchanges in terms of turnover include the Japan Exchange Group, Shanghai Stock Exchange, Korea Exchange, Shenzhen Stock Exchange and Hong Kong Exchanges and Clearing.”

In recent years, some have argued that passively managed funds could trigger the next bubble. Critics say passive investing vehicles such as ETFs are a systemic threat because investors are putting more money into entire indices based on market value rather than buying into the underlying assets themselves.

Also, it is easy for investors to pile on and bail out of their investments. Thus, there is a concern that the popularity of ETFs is causing concentration risk in the market.

Like many market players, Quah does not think there is a reason for investors to be concerned. He says the ETF market is still not larger than the mutual fund market and ETFs do not make sell-offs worse. “What people are mostly afraid of are the underlying assets being affected should there be a huge sell-off. But they have to remember that there are a lot of holdings in mutual funds. The AUM of ETFs are small compared with those of mutual funds.

“If people were to sell their mutual funds, the fund manager — through the redemptions — would have to sell the underlying stocks as well. So, ETFs are not any more dangerous than mutual funds.

“It is also worth noting that market makers are quite sophisticated and have a lot of tools to hedge their exposure such as derivatives that are multiple times the size of its underlying market. If investors are afraid of ETFs as a tool, then they should also be afraid of mutual funds.”

Another issue that has been mentioned is the passive versus active funds argument, says Choy. John Bogle, the late founder of the Vanguard Group, warned the market through writings and interviews that the popularity of index funds could lead to a dangerous vacuum in corporate governance, leaving corporate leaders unaccountable. There is also a possibility of trading drying up, with no active investors setting prices on individual issues.

“Bogle said this would not pose a significant risk until it reaches more than 70% of the mutual fund industry. Right now, even that is still quite a faraway number in the US equity market. Actually, passive fund providers do engage with the companies and look at the development of the market, albeit in a different way,” says Choy.

“I think even if there is a potential for the number to be high, the market has been pretty efficient and self-adjusting. When the market is too passive and starts to affect its efficiency, players will be more active and try to garner from the alpha exposure that it could potentially get from active management at the time.”

Quah thinks the outlook for ETFs is positive within Asia-Pacific as well as globally. He says mainland China’s market, already the fourth biggest in the world, will continue to grow rapidly. “The market is still underdeveloped and quite small compared with its mutual fund market and the amount of savings that its citizens have.

“In the next few years, there will be more players and investors in the market. In view of the technological advancements there, I think it will be easier for people to buy into these funds, either through robo-advisors or other financial platforms. These are the reasons I think mainland China will be the fastest-growing market in Asia-Pacific.”

Quah thinks ETF markets such as Australia, South Korea and Taiwan are some of the fastest-growing in the region. The growth potential of Hong Kong depends on the status of “ETF Connect”, one of the schemes that link the city to the mainland.

Hong Kong established a stock connect with Shanghai in 2014 and Shenzhen in 2016. These were followed by a bond connect, allowing northbound trading, in 2017. The ETF Connect, however, was put on hold as the regulator needed to resolve outstanding issues related to operational, legal and clearing and settlement matters before the launch.

“I believe the infrastructure issues have, more or less, been addressed. Now, it really depends on when the government will announce the launch. Once it is launched, the market should be able to grow quickly,” says Quah.

“Currently, there are uncertainties. We do not know the criteria for the ETFs that will qualify for the scheme. So, when it is launched, we will not be ready with our product.”

Meanwhile, he is hopeful that the entry of three to four new managers in Malaysia will revitalise the country’s ETF market.

i-VCAP’s Khairi says although he is optimistic about Malaysia’s growth, the continuous support of government-linked investment companies (GLICs) is needed for the market to thrive. “We are one of the pioneers. When we started, we received huge support from the government, particularly the Ministry of Finance.

“One of our earliest funds, the MyETF Dow Jones Islamic Malaysia Titans 25, is one of the biggest ETFs in the country. As at Aug 28, the total AUM was RM293 million. This is partly due to the support of the GLICs. Without the support, we would not be where we are today.”

He thinks the collective effort of the players in the ecosystem — including regulators and investors — is needed to move the local industry forward. “With collective effort, we should be able to solve the issues we are currently facing such as a lack of liquidity. Over time, we would like to see some improvements.”

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