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Ex-BlackRock execs target Hong Kong ETFs where others failed

Former executives at BlackRock (BLK) Inc. (BLK) think they've found a way to succeed with Chinese exchange-traded funds where their erstwhile employer failed to gain traction — in Hong Kong.

The key, in a phrase, is multifactor smartbeta.

Premia Partners Co. — established by BlackRock alums Aleksey Mironenko and Rebecca Chua, China Asset Management (Hong Kong) Ltd. veteran David Lai, and former ICBC Credit Suisse Asset Management International banker Laura Lui — is seeking approval from Hong Kong's Securities and Futures Commission for two smart-beta funds targeting global investors in Asia. They would be the first Chinese ETFs globally to use more than one factor in the increasingly popular strategies.

Each fund will contain 300 China stocks with portfolios set up through a multifactor program, which is based on categories beyond market capitalization such as profitability, value, low volatility, asset growth and quality. One of the ETFs focuses on China's old economy, while the other concentrates on China's new economy. The firm plans to start selling them next month and received regulatory approval today.

Premia's ambitions fly in the face of the difficulty higher-profile competitors have had in selling Chinese ETFs. Most notably, BlackRock and Deutsche Asset Management this year delisted China sector funds that failed to gather enough assets.

Bucking trends

"We will continue to expand our offerings in areas where we identify demand from investors," said Marco Montanari, head of passive asset management for the Asia-Pacific region at Deutsche Asset Management. Representatives from BlackRock (BLK) declined to comment.

Overall, Hong Kong's ETF market has shrunk in 2017. But that may change now that index provider MSCI Inc. has included Chinese shares in its gauges. In addition, the Hong Kong Stock Exchange is adding ETFs to its stock connect program, which links securities to the mainland.

"China is an immature market, so excess return is possible if strategies are constructed correctly,'' said Ms. Chua, Premia's managing partner. "Combining factor drivers over the long term leads to a diversification benefit and a consistent excess return.''

Globally, ETF assets are at a record high, but Hong Kong has experienced outflows even as the Hang Seng Index has rallied 28% this year. Some of the reasons are structural, such as the commission-based fee model that encourages banks to push mutual funds instead of ETFs.

Data Science

But Mr. Mironenko, Premia's chief distribution officer, says the end result is that investors are under-served.

"Less than 10 ETFs are regularly traded in Hong Kong," he said. "When there are outflows that's a validation of our plans -- the products are subpar, so we need better versions.''

The firm is betting on data science to help it outperform similar China ETFs. Jason Hsu, co-founder with Rob Arnott of the California investment consulting firm Research Affiliates LLC, is advising Premia, along with Chen Zhiwu, professor of finance at Yale University.

The new economy fund represents industries that may benefit from the Communist Party of China's five-year plan on social and economic development initiatives, Mr. Lai, Premia's co-chief investment officer said. An aging population of 1.4 billion people means demand for nursing homes, biotechnology and legal services like estate planning, plus consumers are upgrading household goods such as air conditioners, he said.

Reflecting the economy

China's A50 equity benchmark is 60% weighted toward financials, which Mr. Lai says isn't representative of the real economy. Investors are concerned that the gauge mainly gives exposure to the old economy, financials and potential non-performing loan problems, he said. In a mature economy like the U.S., an encompassing measure like the S&P 500 Index better represents the economy as a whole, he said.

The firm plans to offer its ETFs for about half the price of a typical fund. The average expense ratio for China ETFs in Hong Kong is 0.99% compared with 0.22% for all U.S. ETFs, according to Premia Partners data. BlackRock (BLK)'s iShares FTSE A50 China Index ETF has a 0.99% expense ratio, while CSOP Asset Management Ltd.'s equivalent fund costs 1.08%, according to data compiled by Bloomberg.

High fees turn off price-sensitive institutional investors in Hong Kong, Mr. Mironenko said. Representatives for CSOP declined to comment.

'Cost advantage'

"There's a lack of competition in the Hong Kong market," he said. "We are aiming for our ETFs to offer a significant cost advantage to investors as we won't have 80% margins and big overheads."

Premia sees enough demand to grow each fund beyond $50 million, a figure that's often seen as a yardstick for profitability. With low fees and an academic approach provided by Research Affiliates, the firm has a sound foundation, according to Eric Balchunas, an ETF analyst at Bloomberg Intelligence.

"It's probably not going to set the world on fire immediately,'' he said. "Multi-factor in the U.S. took some time to get going. But it will likely work long term as smart-beta is delivering active management in a better mechanism.''