The Hong Kong ETF market’s journey began with the launch of the Tracker Fund of Hong Kong (02800), the first ETF on the Hong Kong Exchange (HKEx), on 12 November 1999. It was created as a means of liquidating positions in Hong Kong stocks that the government acquired as it attempted to backstop the local stock market during the Asian Financial Crisis in August 1998.
Twenty years later, we commemorate the progress and investigate the missing ingredients from the Hong Kong ETF market's growth recipe.
Section 1: The Tracker Fund of Hong Kong
1) First ETF in Asia ex-Japan; Largest-Ever IPO
The Hong Kong ETF market began with the Tracker Fund of Hong Kong, the first ETF listed in the Asia ex-Japan region. Japan launched its first ETF in 1995. As an interesting aside, the IPO of the Tracker Fund of Hong Kong was the largest-ever IPO in Asia ex-Japan at that time, at around USD 4.3 billion.
2) Size Matters—Ongoing Charge at 0.09%
The Tracker fund's declining fee structure meant the larger the fund’s assets under management, the lower the fee. At present, the ETF levies an ongoing charge of 0.09%. The fund had HKD 33.3 billion in assets when it was first issued 20 years ago; it has since grown to HKD 83.3 billion as of the end of October 2019. In general, size matters for ETFs, as economies of scale can result in lower fees.
3) Portfolio—The Mix
The Tracker Fund tracks the Hang Seng Index. The composition of the Hong Kong equity market has changed a lot in 20 years—notably, the number of listings of Chinese companies has increased over the years. Before the addition of China H-Shares as eligible stocks in the Hang Seng Index from September 2006, Chinese companies accounted for around a quarter of the index’s value. As of the end of October 2019, Chinese companies accounted for 53.5% of the index’s value, including 26.1% in H-Shares. The Hang Seng Index has served as a barometer of the Hong Kong stock market since November 1969; it started with 33 constituents.
4) Portfolio—The Caps
The Hang Seng Index has undergone a variety of changes over the past two decades. The cap on individual constituent’s weightings was lowered over the years; today, it stands at 10%. The largest component in the index at the time the Tracker Fund’s offering prospectus was released was HSBC Holdings, which accounted for 27.7% of the index’s value as of 20 October 1999. Also, the number of constituents has been increased gradually over the years. The actual number of constituents has been fixed at 50 since December 2012. The ETF held 33 stocks at its inception. Caps on the weightings of individual constituents and an expansion of the number of index constituents has helped reduce concentration risk.
5) MPFs own 16% of the Tracker Fund
According to Ming Pao, MPFs, or Mandatory Provident Funds, accounted for 16% of the Tracker Fund’s assets as of June 2019. In our view, the use of low-cost ETFs can help reduce total cost of investing in MPFs.
6) Total Return 301% From IPO
If investors held the Tracker Fund of Hong Kong from its first listing at IPO price (HKD 12.88) through 12 November 2019, they would have reaped a total return of 301% (with dividends reinvested). This amounts to an annualized rate of return of 7.2%. his compares favorably to 220%, or 6.0% compounded (before tax) on the SPDR S&P 500 ETF Trust (SPY, listed in the U.S.), which tracks the S&P 500, during the same period.
7) The Ecosystem
There are numerous derivatives (futures, options, warrants, and callable bull/bear contracts (CBBCs)) that use the Tracker Fund as an underlying security. As of 13 November, the Tracker Fund has agreements with 18 participating dealers for creations and redemptions of its units. With its size, liquidity, and exposure, the Tracker Fund of Hong Kong plays a central role in the ecosystem of the Hong Kong stock market.
Section 2: The HK ETF Market
8) Assets Under Management
AUM was USD 37.1 billion as of 31 October 2019, excluding cross-listed ETFs. There are some cross-listed ETFs on the HKEx that are very large; for example, the SPDR Gold Trust (02840) has a total fund size of USD 44.5 billion as of 31 October 2019.
9) HK vs the World
According to the data from Morningstar Direct™, global ETF assets under management totaled around USD 5.9 trillion as of 31 October 2019. This puts Hong Kong’s global ETF market share at 0.6%. At USD 4.2 trillion, the U.S. has the lion’s share (72%) of global ETF assets.
10) Number of ETFs in Hong Kong
As of 31 October 2019, there are 211 listed ETFs and leveraged/inverse products (134 products, 77 multiple counters, including 24 L&I products). There are 2000-plus ETFs available in the U.S.
11) Transaction Value
According to statistics from the HKEx, the average daily turnover of ETFs for the first 10 months of 2019 was HKD 4.5 billion. This accounted for 5% of the average daily turnover by value on the securities market of the HKEx.
12) ETF Providers
There are now 23 ETF providers with ETF listings in Hong Kong. Nikko Asset Management and Premia Partners were prominent newcomers in the Hong Kong ETF market in the past three years.
13) The Mix—Asset Class
Looking at the Hong Kong-listed ETF menu through the lens of a local investor trying to build a diversified portfolio, it is clear that broad-based fixed-income products are a gap in the local menu. If we put asset-size considerations into place (for example, screening for funds with AUM of USD 100 million or more), the gap becomes even larger, as product availability is skewed toward China-focused products.
14) From Plain-Vanilla to Leveraged/Inverse
Leveraged/inverse products were first introduced in Hong Kong in June 2016. The rules were recently relaxed to also allow two times inverse products. The first such product was launched in March 2019. For most investors, leveraged/inverse products are generally not suitable as buy-and-hold investments. In general, they are more suitable for traders who understand how leveraged/inverse ETFs work as a short-term trading and speculation tool, and for investors looking to use them as a short-term hedge.
15) From Passive to Active
Regulations specific to active ETFs in Hong Kong came into force at the beginning of 2019. The first active ETF in Hong Kong was listed in June 2019. The fund offers exposure in the USD money market. Active ETFs only accounted for a small portion of the U.S. ETF market, at around 2% in assets under management as of the end of October 2019.
16) What’s Missing?
The product menu is just one area of the Hong Kong ETF market that could use more attention. In our view, other missing ingredients from the Asia region’s growth recipe still apply to Hong Kong, namely: investor education, distribution, and scale.
17) Missing Ingredient Number 1— Investor Education
According to the “Retail Investor Survey 2019” published by the HKEx in May 2019, “ETP are gaining popularity with around 15% of the Hong Kong population being ETP investors.” This compares to a reading of 7% in 2011. However, this is far less than the 56% figure for stocks. Anecdotally, retail investors in Hong Kong are generally unfamiliar with ETFs and the pros and cons of using them in a portfolio. We believe investor education is important for retail investors, especially as it pertains to how ETFs can be used to invest for retirement and in MPF schemes.
18) Missing Ingredient Number 2—Distribution
Morningstar published the “Global Investor Experience Study: Fees and Expenses” in September 2019, in which we noted that fund distribution in many Asian markets, including Hong Kong, is dominated by local banks that do not have an incentive to sell ETFs to individual investors. A shift to fee-based advisory that we have seen in other markets, such as the U.S. and Australia, could help the further development of the ETF market.
19) Missing Ingredient Number 3—Scale
The Asia ETF market is very fragmented. This limits the scalability, and local rules and regulations could limit accessibility of different products to investors in the region. We believe ETF passporting schemes among a wider network of markets within the region could increase the overall size of the market and allow ETFs to ultimately achieve economies of scale. The connectivity of the ETF markets in Hong Kong and mainland China remains an area where industry participants see huge opportunities.
20) Future of the HK ETF Market
Hong Kong is uniquely positioned, especially given its proximity to China. With China further opening its capital market, Hong Kong’s ETF ecosystem can capture the upcoming opportunities while tackling any potential challenges and obstacles. In addition, ETFs are a global product, and globalization can likely bring ETFs closer to investors’ doorsteps. Exchanges and ETF providers will need to continue to adapt in order to provide the best products to global investors. Only the best products for investors can survive for the long run.
