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ETFs: Go further, do more
Asian Exchange-Traded Funds (ETFs) offered a broad range of possibilities to investors which were not being fully utilized yet, a panel of leading market participants told the Asian Investment Conference today.
ETFs offer investors multiple benefits, including liquidity, tradability and reduced execution costs, said panelists at Credit Suisse’s AIC, but investors’ understanding of the product and its full possibilities remains underdeveloped.
“Despite the fact that it has been 18 years since the first ETF, education remains the biggest challenge,” said Joseph Ho, Head of ETFs for Asia Pacific at Credit Suisse. He referred to a recent Credit Suisse survey of Independent Financial Advisors (IFAs) in the UK in which 51% of IFAs reported that their understanding of the product was “basic” while 19% said they had “no understanding”.
The panel began by addressing one of the most debated aspects of ETFs: the differences between traditional ETFS, which hold the stocks that underlie their valuation, and synthetic ETFs, which track baskets of stocks or indices using derivatives. The relative strengths and weaknesses of synthetic ETFs have been a talking point since the collapse of Lehman Brothers in 2008 made counterparty risk a heightened concern for investors and regulators around the world.
“ETFs are a very important tool for hedge fund managers,” said Jeffrey Weber, the President of hedge fund York Capital Management. But he said that potential investors often asked him whether his short positions had been achieved via synthetic ETFs, implying that this was somehow “cheating” in the context of a hedge fund.
But Rolfe Hayden, Partner at Simmons & Simmons in Hong Kong, pointed out that any swap-based ETF in Hong Kong must be at least 90% collateralized under local regulations. “In buying an ETF, you are protected against the counterparty risk of the swap counterparty,” he said.
“I don’t think synthetic ETFs are evil,” said Sammy Yip, Director of Business Development at Lippo Investment. “I think it’s a matter of [whether] proper risk controls are in place and whether investors and users understand ETFs.”
With more than 7,000 ETFs listed globally, investors can use these instruments to express views on more asset classes than ever before. “The spectrum of ETFs is very wide,” said Mr. Yip. “You can have a lot of choices and tools within your ETF toolbox.” Beyond equities, Mr. Yip said that it was possible to use ETFs to gain exposure to underlying fixed income and commodities assets and that investors could also use inverted and leveraged ETFs.
Howard Lin, Trader at LaBranche Structured Products, emphasized the importance of liquidity in ETF markets, distinguishing between primary and secondary liquidity. He said that authorized ETF market-makers provide primary liquidity when they “create” or “redeem” ETF units for clients through over-the-counter transactions. Secondary liquidity is provided through exchange-based trading in the existing listed units and conducted via trading screens or over the phone.
While “primary” OTC trading accounted for around 60% of ETF flows in Europe and 30% in the US, Mr. Lin said that investors in Asia Pacific still preferred to trade on screen during Asian market hours. He argued that they should consider using OTC more, saying it “almost always” offered a better price as market makers were prepared to assume some risk and offer more aggressive prices to win business. “The more market-makers involved, the better and the more liquid for ETFs,” he said.
Mr. Weber agreed on the importance of being able to trade ETFs cheaply and easily in substantial volumes. “What we primarily look at is the liquidity of an ETF,” he said. Mr. Weber added that his firm used ETFs for four main purposes: achieving basic market exposure, isolating alpha in mergers and acquisitions situations as part of their event-driven strategy; taking long exposure associated with a commodity or industry to hedge against “tail risk” or inflation; and for risk management through tracking ETFs – rather than investing in them – to measure a portfolio’s beta to a certain sector.
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Day 4: Photo Album
