For our sixth consecutive year providing insight into the investor uses of ETFs, we produced a global survey, capturing responses from institutional investors, financial advisers, and fund managers in the US, Europe, and Greater China. To provide further detail on the Greater China region, we developed this supplement, which focuses on the responses from three key markets: Mainland China, Hong Kong, and Taiwan.
Historical performance and ETF issuer are top of mind.
In lock step with US and European investors, historical performance was cited as the most important selection criteria for investors in Hong Kong and Taiwan, highlighting interest in products that can mitigate risk or generate outsized returns. In Mainland China, however, ETF issuer and index methodology stood out as the top drivers of ETF selection.
Holdings in ETFs are set to rise, especially in Mainland China.
63% of respondents in Greater China plan to increase the ETF allocation within their portfolios in the next 12 months. In Mainland China, however, 77% plan to increase their ETF allocations. Over 60% of respondents in Mainland China have at least a quarter of their AUM in ETFs – nearly double the amount reported last year.
Global interest in Mainland China continues to grow.
Roughly 70% of European and US respondents have plans to invest in the China capital markets this year. These investors were split as to how they will execute that investment with half planning to leverage ETFs and half expecting to make direct investment through the existing inbound access schemes (RQFII, Stock connect, etc.)
Smart beta is catching assets from mutual funds, moving the products from newcomer to portfolio staple.
97% of respondents in Greater China have at least one smart beta ETF in their portfolio. 38% of respondents purchased a smart beta ETF in the last 12 months to replace an actively-managed mutual fund. Investors in Taiwan were the most active in using smart beta ETFs to replace active mutual funds with 65% of respondents having done so in the past year.
Active, smart beta, and ESG products round out the ETF wish list.
The top ETF strategies respondents most want to see listed in their local market are active, smart beta, environmental, social, and governance (ESG), and core index.
Mainland investors show strong interest in accessing Hong Kong ETFs.
98% of Mainland China respondents are interested in buying Hong Kong ETFs either through the Stock Connect or Mutual Recognition of Funds (MRF) programs. If granted access to Hong Kong ETFs, Mainland investors selected Hong Kong and Asia Pacific equity ETFs as the products with the highest potential for demand.
Brown Brothers Harriman (BBH), in partnership with ETF.com, recently surveyed 300 institutional investors, financial advisers, and fund managers from around the world (100 in the US, 100 in Europe, and 100 in Greater China – including Mainland China, Hong Kong, and Taiwan). This supplemental report takes a closer look at the Greater China responses. Click here to read the full global report. In Greater China, the sample consisted of 27% institutional investors, 61% financial advisers, and 12% fund managers. All respondents invest in ETFs and are aware of their institution’s overall investment strategy.
Unless otherwise indicated, data sources for all results are BBH surveys and all numbers are in US dollars.
The Greater China ETF Market in Context
Mainland China is driving ETF usage in the region
Comparing ETF investment across regions reveals a maturing global ETF market. Globally, the majority of respondents (67%) hold 11-50% of their portfolios in ETFs. That number is 66% for the US, 60% for Europe, and 73% for Greater China. On the upper end of the AUM spectrum, 13% of both US and European investors said ETFs made up at least half of their portfolios. This compares with just 7% in Greater China.
Ongoing education efforts around the structural benefits of the ETF wrapper seem to be resonating as 38% of Greater China respondents have at least 26% of their AUM in ETFs. This represents an increase of 7 percentage points from the 2018 BBH Greater China ETF Investor Survey. This increase was driven by Mainland China respondents, where 63% of respondents have at least 26% of their AUM in ETFs — nearly doubling from 32% last year.
Holdings in ETFs set to rise, especially in Mainland China
In a sign that the Greater China ETF market will continue to grow, the majority of respondents (63%) plan to increase their ETF investments in the next 12 months, up from 56% last year. Mainland China investors propelled the increase with 77% of investors expecting to increase allocations to ETFs this year, compared to 43% last year. This interest is aligned with growth in the Mainland China ETF market, where assets grew by 31% in 2018.1
Historical performance and ETF issuer are top of mind
When selecting ETFs, investors’ top three criteria in Greater China are historical performance, expense ratio, and ETF issuer. Last year, index methodology ranked first, followed by historical performance, and a tie between trading spreads and trading volume.
The emergence of historical performance may come as a surprise to those who subscribe to the conventional wisdom that cost is the single most important criteria for ETF selection. Results show expense ratio is significantly less important to investors in Greater China compared to the US and Europe. As ETF adoption by retail investors in Greater China is still at a nascent stage, perhaps investor sensitivity to fees is less acute than in other regions. When compared with regional mutual funds, ETFs on the higher end of the expense ratio – such as active or smart beta ETFs -- still often present a significant cost value.
Investors are comfortable buying ETFs with low AUM
Nearly all investors have a “rule of thumb” for a new ETF before investing. In Greater China, many investors are comfortable buying ETFs with low AUM: 47% said they would buy a new ETF with less than $24 million in assets. In last year’s survey, 41% of respondents preferred $50 million as their minimum fund size. Given the nuances with ETF seeding and recent trends for larger issuers self-seeding new ETFs (thereby underscoring commitment to their product set), perhaps investors are more willing to take on the risk of a newly launched ETF with lower AUM.
Even though investors are comfortable buying ETFs with smaller AUM, many institutions keep a $100 million threshold as the preferred minimum fund size. 41% of Mainland investors and 36% of Hong Kong investors prefer an ETF with at least $100 million in AUM, while only 10% of investors in Taiwan use $100 million as their “rule of thumb.”
Investors are looking for more smart beta and ESG ETFs
The top ETF strategies that respondents most wanted to see listed in their local market are active, smart beta, ESG, and core index.
In Hong Kong, respondents marked smart beta as the top strategy they want to see more, even as nearly 30% of the new ETF listings on HKEX over 2017 and 2018 were smart beta products.2
The interest in active management is also an area to watch this year in Hong Kong. In January, the Hong Kong Securities & Futures Commission (SFC) announced regulations allowing issuers to launch active ETFs. Active management continues to have a strong position in Asia and the ability to launch active strategies in a low-cost wrapper could be attractive to investors. Currently, active ETFs are not allowed by the respective regulators in the Mainland or Taiwan.
Demand for ESG strategies is increasing with Mainland and Taiwanese investors ranking it in their top two choices. Across Greater China, there currently is only one ESG ETF,3 which is in Mainland China; however, regulators have been taking steps to increase adoption of socially responsible investing. The China Securities Regulatory Commission has introduced new reporting obligations for listed companies to disclose ESG risks in their annual reports. The Hong Kong SFC announced their green finance strategic framework late last year, which focuses on several initiatives including its own disclosure requirements of environmental information for listed companies. Institutions have been the first movers when it comes to ESG adoption and Taiwan is a great example: the Bureau of Labor Funds (pension) has been an active allocator to ESG mutual funds since 2016. ESG ETFs are still new globally, but given increasing interest from respondents, this will be an area to watch in 2019.
Investors also want to see more fixed income and US equity ETFs
The top asset classes that investors across the region think could use more ETFs are fixed income, US equity, commodities (including gold, oil, metals, energy, food, etc.), and alternatives. These selections might be attributed to investors seeking a flight to more stable and less correlated asset classes given the market volatility experienced in 2018, and which some expect will continue through 2019.
Accessing Mainland China
US and European investors set to increase allocations to Mainland China
Given its growing importance in the global economy, outside investors are increasing their exposure to China. This is aligned with China’s ongoing index inclusion process, which began in 2018 when MSCI started to include A-shares in their flagship Emerging Markets benchmarks. In February 2019, MSCI announced the next stage in A-shares index inclusion. The existing inclusion factor of 5% in the Emerging Markets index will be increased to 20% through three steps that will be completed by November 2019. The A-shares weight in the pro forma Emerging Markets index will increase to 3.3% after the completion of the three steps. Analysts expect close to $70 billion of inflows into Chinese A-shares in 2019 with index inclusion being a driving factor.4
Also, in January 2019, Bloomberg confirmed that Chinese government and policy bank bonds will begin to be added to the Bloomberg Barclays Global Aggregate Index in April 2019. The inclusion process will take 20 months and analysts expect $150 billion of inflows into the China bond market from this process.5
With additional China equity inclusions and the first China fixed income index inclusion scheduled for 2019, investors will need to allocate to China or risk tracking error for their passive strategies. ETFs are well positioned as access tools, especially for asset managers in the US and Europe who may not want to manage the operational complexity that comes with direct investment access via the existing inbound access schemes.
69% of US and 71% of European respondents have plans to invest in the China capital markets this year with a relatively even split between leveraging ETFs and making direct investments through the existing inbound investment channels.
Mainland investors have a slight preference for cross listing when accessing Hong Kong ETFs
When the extension of the Shanghai-Hong Kong Stock Connect program to Shenzhen was announced in August 2016, a commitment to someday include ETFs in that program was included as well. Since then, normalizing the settlement infrastructure between the respective exchanges has been one of the issues delaying the inclusion of ETFs. As a result, regulators have begun to review alternative options for mutual market access for ETFs, including cross listing ETFs, through the existing MRF program that is already in place for mutual funds between the Mainland and Hong Kong.
When asking Mainland investors about their preference for accessing Hong Kong listed ETFs in the future, half of respondents said they would buy ETFs that are cross listed on the Shanghai Stock Exchange. Meanwhile, 40% said they would buy Hong Kong ETFs through the Stock Connect program. Without clear requirements currently in place, investors seem to have a small preference for the MRF program, but cross listing will potentially bring added complexity and cost to ETF issuers dependent on how the Mainland listing is facilitated. Regardless of the channel, the market is waiting for regulators to address the operational aspects of this cross-border program prior to the implementation.
Hong Kong and Asia Pacific equity ETFs could be in demand
If a program providing Mainland investors with access to Hong Kong ETFs launched, 63% of investors would be interested in Hong Kong and Asia Pacific equity ETFs. This remains consistent with the 2018 results, where 65% of Mainland investors preferred Asia Pacific equity, followed by 60% who were interested in Hong Kong equity ETFs. It is still not clear which asset classes would be eligible through this type of mutual market access program, but the regional investment focus of Mainland investors appears clear from the responses.
Active and Smart Beta
Smart beta demand remains strong
While smart beta and active ETFs represent just 17%6 of the broader global ETF market, their relevance has increased significantly in recent years. Broken out by region, 97% of respondents in Greater China have at least one smart beta ETF in their portfolio. That number is 94% in Europe and 92% in the US.
38% of respondents across Greater China expect to increase their exposure to smart beta products in the next year. This demand is led by investors from Taiwan and the Mainland where 45% and 40% of respondents, respectively, expect to increase allocations to smart beta this year.
Smart beta ETFs are catching assets from mutual funds
Smart beta is often cited as the middle ground in the active-to-passive spectrum. It appears that investors view smart beta ETFs as vehicles that could combine certain benefits of traditional active management, when compared with passive core index ETFs, and lower costs.
In fact, 38% of Greater China respondents purchased a smart beta ETF in the last 12 months to replace an actively-managed mutual fund. Taiwan investors are leading the way as 65% of respondents have reallocated investment from active mutual funds to smart beta ETFs in the past year.
In Mainland China, a market historically dominated by active mutual funds, the ongoing regulatory reforms focusing on deleveraging the financial markets and reallocating investment from wealth management products into more transparent collective investment vehicles, should be a tailwind increasing the use of ETFs, including smart beta.
Equity asset classes draw most active ETF attention
More than 50% of global respondents would look for an actively-managed ETF in equity asset classes. If and when investors in Greater China have the opportunity to access active ETFs in their local market, equity strategies are expected to be the top choice. In the Mainland, domestic equity was the top response (42%), while global equity (42%) was favored in Taiwan. Hong Kong investors showed a slight preference for global equity (32%) over domestic equity (26%).
In a region where fund distribution continues to be dominated by the bank channels and incentivized by commissions, issuers of active ETFs will need to balance existing intermediary distribution relationships and the potential for their active strategies to be sold on exchange at a potentially lower cost.
ETFs and Market Exposure
Investors seek fixed income ETFs in volatile markets
During periods of heightened market volatility, respondents across Greater China said they will buy fixed income ETFs (59%) and low volatility smart beta ETFs (46%).
Although intraday liquidity is often a selling point for ETFs, it’s not the main reason investors are buying them. It appears access – especially to asset classes such as fixed income, or nuanced strategies such as low volatility – is compelling many to use ETFs opportunistically.
Investors prefer stocks over ETFs for sector exposure
Sector exposure is often seen as a smaller segment of portfolio construction, one that appears many investors prefer to achieve through individual stocks. However, 30% of investors (the second most) achieve sector exposure through ETFs, underlying investors’ belief in the power of ETFs in achieving that goal. Taiwan investors took a more balance approach providing equal weighting (40%) to using sector specific ETFs and buying sector specific stocks.
Potential Headwinds for ETFs
Access and trading cost are the main challenges
31% of respondents in Greater China stated that the platforms they use make ETF trading difficult or expensive. While platform issues could be a potential headwind in further ETF adoption, the results highlight how much opportunity exists for global intermediaries to continue to improve the user experience and make trading ETFs more cost effective.
Liquidity of fixed income ETFs is a concern
Regarding fixed income ETFs, liquidity and tracking error are the main concerns for investors in Greater China. Liquidity was the top response for Mainland investors (45%), potentially highlighting the liquidity challenges resulting from corporate bond defaults in the China bond market. Meanwhile, trading volume was the most important concern for Hong Kong respondents (28%), which aligns with responses from US and European investors.
ETF education efforts are paying off in Greater China
In Greater China, the number of respondents who selected “I don’t feel I fully understand ETFs” and “I don’t know how to pick the best ETF” dropped sharply from last year. Whether through asset managers, the media, or the broader ecosystem, it appears investors are becoming more knowledgeable and comfortable with ETFs, demonstrated by the regional ETF market growth and maturity.
Last year, in our inaugural Greater China ETF Investor survey, growth was a theme that hinted at a bright future for ETF product development across the three markets of Mainland China, Hong Kong, and Taiwan. Despite 2018’s market volatility, ETF AUM for these three markets grew 18%, from $92 billion to $108 billion.7 This year’s results tell a similar story: The Greater China region continues to embrace ETFs and product innovation will accelerate growth.
Similar to last year, we believe regulatory developments will be a catalyst for further investor adoption of ETFs. In Mainland China, the regulatory landscape is evolving with a clear focus on deleveraging and strengthening the asset management industry. The development of the third-pillar pension scheme is a key factor to watch, as ETFs and other passive products may become important building blocks for target date funds. In Hong Kong, the new designated specialist program was implemented late last year and should encourage additional market makers to be active in Hong Kong. Issuers are also optimistic about the flexibility that the listed/unlisted share class can bring as they look to scale their ETF platforms. Finally, in Taiwan, insurers have been an important part of the growth in fixed income ETFs as they have looked to offshore investments to find higher yields. ETF feeder funds head the regulatory agenda in Taiwan this year, and issuers are optimistic about the opportunity to expand the use of ETFs through these funds, once approved by the regulator.
However, the regional outlook still presents challenges. A key obstacle continues to be the commission-based distribution platforms that are prevalent in the region but do not align with a structural benefit of the ETF wrapper (i.e. low cost). Enhanced disclosure requirements have increased the transparency of these fee arrangements and could drive investors into lower cost products over time, but for now it is a large barrier for widespread ETF adoption by retail investors.
With that said, wealth generated in Asia (especially Mainland China) is growing at an unprecedented pace. Wealth generated by high net worth individuals in Asia is expected to double from $21.6 trillion in 2017 to $42 trillion by 2025.8 Mainland investors are also looking for opportunities to diversify their investments, which has been amplified with the recent volatility in the onshore capital markets. ETFs are well positioned to be a key product for capturing the increasing wealth and offshore demand.
Regional issuers have been eagerly awaiting a cross-border program to add another channel, outside of Qualified Domestic Institutional Investor (QDII), for Mainland investors to access global investments. The current options regulators and exchanges are evaluating include adding ETFs to the Stock Connect program that connects the Shanghai, Shenzhen, and Hong Kong exchanges or through a potential cross listing scheme leveraging the MRF infrastructure. The benefits and potential challenges of these options are well documented, but there is an expectation that a cross-border ETF program between the Mainland and Hong Kong will progress in 2019.
As highlighted in the survey responses, we expect the tailwinds of increasing ETF adoption, regulatory change, and product innovation to accelerate growth in the Greater China ETF market this year. As a result, Greater China will be a focal point for ETF issuers as they look to position themselves to capture this increasing demand in 2019 and the years to come.
If you would like to discuss the survey or learn more about ETFs, please let us know. We look forward to collaborating with you.
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5 “China’s Capital Markets: A Progress Report.” FT Alphaville, 2019.