Spurring ETFs’ trading growth
Cheah Chor Sooi 
Lack of appeal to investors has persistently stunted the growth of ETFs in Malaysia, says Goh


HE true potential of exchange-traded funds (ETFs) can probably be best “unearthed” with the participation of big-time institutional investors.

Currently, the level of understanding regarding ETFs among retail investors remains low while at the institutional level, most assets managers do not include ETFs in their portfolios.

An ETF is essentially an open-ended fund – much like a unit trust – but is listed on the stock exchange. Howover, it does not impose sales charge and has lower management fees (less than 1% compared to managed funds).

Moreover, fund managers – unlike those in more developed markets – generally prefer an active stock-picking approach rather than utilising a core or satellite strategy using ETFs, according to i-VCAP Management Sdn Bhd acting CEO Zulkifli Ishak.

Malaysian fund managers generally prefer an active stock-picking approach rather than utilising a core strategy using ETFs, says Zulkifli

In developed ETF markets, institutional fund managers create a sizeable core portfolio using ETFs as a base while seeking alpha from the balance of the portfolio by actively selecting individual stocks.

“There is also a missing link for product wrappers from the asset management and insurance/takaful [Islamic insurance] industries in terms of utilising ETFs as a tool to access foreign markets,” he tells FocusM.

Malaysia currently has only three ETF issuers managing eight funds (a stark contrast from 637 unit trust funds as of end-June), namely AmFunds Management Bhd, i-VCAP Management Sdn Bhd and CIMB-Principal Asset Management Bhd. As of end-December, trading value stood at RM1.51 bil while trading volume amounted to 1.38 billion units.

Total returns from ETFs between June 1, 2016 and July 31 range from 4.06% to 39%.

List of exchange-traded funds (as of end-August)

In Japan, ETF trading volume grew rapidly when the Bank of Japan (BoJ) started buying into ETFs as part of its monetary easing measures. As of end-2015, BoJ had about ¥7 tril (RM263 bil) out of ¥16 tril of total ETF assets under management (AUM) in Japan.

In the case of Taiwan, the Financial Supervisory Commission, the country’s top financial regulator, has eased rules governing risk-based capital ratios to allow local insurance companies to have more disposable funds to invest in stocks as well as ETFs.

“We certainly have much room to grow, as AUM in the ETF market was less than RM2 bil as of end-June compared to RM409 bil for Malaysia’s unit trust industry,” suggests Zulkifli who is also i-VCAP Management’s head of business development. “The initiative from the Employees Provident Fund (EPF) to allow investment from its savings has actually helped to enhance the unit trust AUM in a significant way.”


Pushing ETFs to greater heights

REGARDLESS of its slow growth rate, market regulators Bursa Malaysia and the Securities Commission (SC) have been supportive to grow the fund size, depth and breadth of exchange-traded funds (ETFs) listed.

In May, an ETF task force chaired by the SC and comprising Bursa Malaysia, fund managers, market makers and institutional investors was set up to attract greater investor participation and incentivising issuances by ETF managers in the market.

Some of the key recommendations are:

▶ Reducing the minimum capital requirement for ETF issuers from RM10 mil to RM2 mil to encourage the issuance of more new ETFs.

▶ Broadening of the ETF distribution channels by permitting financial institutions, online platforms and financial planners to offer ETFs to clients via stockbroking companies. The use of such alternative distribution channels will provide investors greater access to a more diverse range of products at a lower entry cost.

▶ Facilitating the introduction of new types of ETFs, including those which are futures-based and conventional commodity-based. This will provide affordable entry points to retailers in traditionally difficult-to-access investments such as physical gold and foreign futures market.

Adding further impetus to the task force’s recommendations, Bursa Malaysia is providing a 100% clearing fee rebate, as well as a full waiver of transfer and securities, borrowing and lending fees to ETF market makers to provide trading liquidity to ETFs.

Elsewhere, the local bourse has also increased the number of investor education programmes to raise investors’ awareness and understanding of ETFs. As of end-August, the exchange has organised 64 investor education activities nationwide on the benefits of investing in ETFs.

Another 38 are expected to be conducted by the end of this year, a 67% increase of ETF-specific education and marketing initiatives planned for this year compared to only 61 such initiatives last year.


Poor retail investor appeal

AmInvest acting CEO Goh Wee Peng says that the lack of awareness and low product comprehension factors partially contribute to the low rate of participation in Malaysian ETFs.

“However, it is the ETFs’ lack of appeal to investors that has persistently stunted the growth of ETFs in Malaysia,” she says. “ETFs should be used by investors to build a diversified portfolio for the long term.”

Unfortunately, many local investors tend to be short-term trading oriented with preference on stock specific ideas. Hence, there appears to be a basic mismatch between what retail investors expect and what ETFs are able to offer.

“One way of addressing this matter would be to develop short or leverage ETFs/vehicles to encourage shorter/intraday trading,” Goh points out. “Another proposition would be to make ETFs easily available and eligible under retirement savings schemes and pension plans for longer term investments.”

Moreover, the existing ETFs do not appeal to local retail investors given they are spoilt for choice if compared to actively managed unit trusts which are generally still able to deliver the alpha or excess returns compared to the market.

“In comparison, our present ETFs are index-tracking, hence their returns would generally be giving the market or index returns,” she observes. “This is a phenomenon that occurs in emerging and still-developing markets.”

ETFs’ assets under management in the US passed the US$3 tril (RM12.69 tril) mark this year, having grown by 20% between 2015 and last year. This was sparked by the availability of registered investment advisers who are incentivised to introduce low-cost products to their clients.

In the UK, the spur of ETF growth came from the fact that financial advisers can no longer take remuneration as a percentage. They have to get used to fee-based services rather than trailer commission.

For much of Asia – Malaysia included – the mutual fund industry pays commission to intermediaries such as banks, brokerages or financial advisers that might recommend them.

Unfortunately, ETFs are disadvantaged because they are traded openly at stock exchanges and not structured to pay commission. In a way, a vibrant ETF market does hinge on the evolution of fee-based advisory model and networks.

In Japan, the regulators are encouraging fee-based sales with a new fiduciary code for this objective. Drawing lessons from the Japanese experience, Australia has introduced reforms to increase the transparency around fund pricing, thus encouraging the growth in ETFs.

According to i-VCAP’s Zulkifli, the Malaysian ETF market is experiencing low trading volume and wide bid-offer spreads which leads to less competitive pricing. Feedback from market makers indicate that the opportunity cost for them to hold ETFs for the purpose of market-making is high.

“Investors tend to shy away when faced with the wide spread which compounds the low trading volume issue further,” he reckons. “Ideally, market makers are supposed to provide liquidity for retail investors on the exchange.”

On the other hand, institutional clients and high net-worth individuals can always bypass the secondary market and focus solely on the primary market by leveraging a principal dealer or opt for in-kind or cash creation and redemption.

Moreover, the management fee of ETFs are slightly higher compared to regional ETFs. Currently, ETFs with equities as their underlying assets – plain vanilla ETFs – charge between 0.4% and 0.75% while regional ETFs charge more competitive fees, eg between 0.18% and 0.35% in Hong Kong.

“Fees are even cheaper when you look at the US where they are less than 0.1%,” asserts Zulkifli. “If we can bring the cost of buying into ETFs down, we may be able to attract more institutional investors who have previously only been looking at regional ETFs.”

AmInvest’s Goh views that challenges relating to costs, regulations and the resulting lack of trading activity still persists although the ETF market in Asia has generally indicated growth (ie in Taiwan, South Korea and Japan).

“ETFs are liquid as long as the market makers are there quoting bid and offer prices at the exchange,” she rationalises. “When the market could see that money could be made as a market maker, there will be more players in the market. It boils down to demand for ETFs.”

This article first appeared in Focus Malaysia Issue 254.