The appeal of ETFs moves up a gear

Exchange traded funds have grown in stature of late, offering some distinct advantages in portfolio management that in volatile markets are increasingly appreciated

The use of exchange traded funds (ETFs) is expected to grow despite – and perhaps because of - the extremely volatile markets forecasted for the duration of 2019.

ETFs capture beta, a measure of the risk arising from exposure of a stock to general market movements, and therefore in a market environment like 2018, when all asset classes except cash underperformed, ETFs will also underperform.

However, ETFs can be helpful when investors are de-risking their asset allocation in any market condition. This means that even in a market environment like 2018, ETFs will provide the investor flexibility to be able to quickly switch his portfolio's positions.

"For example, when one particular market does not look optimistic then ETFs provide a very quick way to get out of that market and switch the exposure to some other market. Imagine if you have 30 China stocks in your portfolio, to sell those 30 stocks and move it somewhere else would require doing several trades," says Phillip Yeo, international head of product development & management and joint global head of ETF business at Nikko Asset Management Asia.

"But if you have a China ETF instead, you only have to make two trades. You sell the China ETF, then you buy another somewhere else. It's very efficient so you can move very quickly," he adds.

In 2019, the use of ETFs in Asia is expected to continue its growth because of increasing awareness among investors of the usefulness of ETFs in portfolio management.

"Whether it's among retail investors, family offices, fund managers, or sovereign wealth fund managers, ETFs are a very efficient way to access beta. In this region, sometimes the typical fund manager may feel disinclined to invest in ETFs because they feel a moral obligation to stock pick. But I think that trend is changing," Yeo says.

In addition to asset allocation, there is also greater awareness among institutional investors with huge temporary cash positions in the use of ETFs for cash equitization. By using ETFs for cash equitization, a fund manager can tap market beta quickly and efficiently without having to invest in individual shares of stock.

"Let's say the fund manager has just recently launched a product and he raised US$100 million. He may find it difficult to access all markets he needs to invest in on day one. So, in order to get the beta without finally filling out his stock picks he might just buy an ETF in the meantime," Yeo says.

Cash equitization is particularly useful in markets like India and Vietnam where foreign fund managers need to secure government approval to be able to buy domestic shares and seeking these approvals can be a time-consuming process.

"In the Indian market it might take two to three weeks to get the fund the approval to buy the local stocks. So sometimes the fund manager may say why don't I just buy India ETFs to capture the market beta first. After I get my approvals sorted out, then I will do my stock picking. That's just an example of what we call cash equitization. You equitize the cash very early without losing out on the market movement," Yeo says.

Focused mainly in Singapore, Nikko AM's ETF business in Asia ex-Japan has grown by 20% per annum in assets under management (AUM) to S$1.5 billion in the past five years. It has two bond ETFs, an equity ETF, and an Asian reit ETF.

Going forward, Nikko AM is planning to launch new ETFs in Singapore, Hong Kong and across the Asean bloc.

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