A new investment tool – Fund of ETFs – was unveiled at Morningstar’s Hong Kong ETF Intelligence Seminar in September. Based on the same concept as Fund of Funds, Lippo Investments Management (Lippo IM) launched its first Fund of ETFs in Asia last November, to be followed by more Funds of ETFs in the coming months targeted at high net worth individuals (HNWI) and institutional investors. To introduce this instrument to investors, we invited Conrad Cheng, Chief Investment Officer, and Sammy Yip, Head of Business & Product Development, from Lippo Investments Management to share with us how they use the ETF as an investment tool to build portfolios.
It is not common practice in Asia to use ETFs as a major investment tool. “We appreciate ETFs’ tradable nature and the wide variety of asset classes and strategies available. Transparency and low costs are also features that we like.” Conrad said. “We see some private banks using ETFs for ultra-high net worth individuals’ discretionary accounts, albeit not in a significant fashion. However, if we can fully utilize the advantageous features of ETF, portfolio can be constructed using strategies similar to hedge funds. Furthermore, frequent trading strategies can be established using ETFs.”
Liquidity weighs on cost
Obviously, a “Fund of ETFs” portfolio is more flexible than a “Fund of Funds” portfolio. How does the team pick the “best” ETF? Sammy explained that they evaluate ETFs in both a quantitative and qualitative manner. “Quantitatively we look for good liquidity and low tracking errors in an ETF. Cost, from the perspective of expense ratios and price premium/discount, is another consideration. Qualitatively, we examine the investment and legal structure of the ETF.”
Sammy believes the most crucial factor in considering whether to invest in an ETF is liquidity. “Liquidity has a direct impact on trading spread. The lower the liquidity, the wider the spread. This will raise cost eventually.” Higher cost erodes the asset base, which is at odds with the low-cost concept of ETF. This is the most important risk when using ETFs. Conrad commented, “Many ETFs are screened out after the application of liquidity criteria. This is not the case in just Asia, but even developed ETF markets like the US.”
Management skills matter
Liquidity is the first and foremost risk consideration. However, investors should not overlook other risk factors such as tracking error risk, high expense ratio, etc. When managing an ETF portfolio, balancing portfolio risk and generating alpha require management skills. “Different asset classes and strategies incur different risks. The point is, as a professional investor, we need to identify the risks and make use of the uniqueness of different types of ETFs to add value to the portfolio.”
The ETF market in Asia is incipient. ETF market liquidity is still very low in the region. Sammy points out that the compensation scheme is one of the obstacles for the development of the ETF market. “In Asia, the IFA, private bankers or brokers are compensated generally by transaction, unlike the US or Europe where compensation is fee-based, so there is no incentive for sales representatives to promote low-cost products such as ETFs.”
It is all the same in Asia
This situation is very similar to what we see in Japan. From an interview with Katsunari Yamaguchi, the President of Ibbotson Associates Japan, ETF liquidity and turnover in this part of the world is far from that in the West. Liquidity risk is a concern for investors, both professional and retail. Sammy hopes that the market will develop. As the ETF market matures, investors will have a broader array of investment instruments, enabling them to pick what is right for them.
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Lippo Investments Management Limited (“LIM”) is wholly owned by Lippo Limited, a listed company on Hong Kong Stock Exchange. LIM is a macro-driven manager which develops transparent, tangible and cost-effective investment solutions for Asian high net worth individuals and institutions via “Fund-of-ETFs” approach. Construction of “Fund-of-ETFs” is based on practical and structured macro modeling, ETF research and efficient implementation procedures.
