ETF managers focusing on Asia-Pacific opportunities

Asia-Pacific policymakers have been prime movers, wittingly or unwittingly, in boosting the region's exchange-traded fund market, with local money managers capturing the bulk of the resulting opportunities.

Foreign managers, by contrast, are focused for now on the growing ranks of institutional investors in the region eyeing overseas ETFs as a means of diversifying their portfolios.

The Bank of Japan has had the largest impact on the market since 2013, when the central bank began buying billions of dollars of Japanese equity market ETFs every month in an effort to support the country's economy.

The BOJ's ETF holdings have grown to ¥26.63 trillion ($247 billion), or more than 40% of the $599 billion Asia-Pacific tally — as of June 30 — compiled by London-based independent research and consultancy firm ETFGI LLP.

The BOJ's holdings are roughly equal to the combined $244.3 billion of ETFs listed in the 14 Asia-Pacific markets besides Tokyo tracked by ETFGI.

Other regulatory moves that have spurred ETF growth in the region include Taiwan's decision to let local insurers work around a ceiling on overseas investments by buying Taipei Stock Exchange-listed ETFs with underlying exposure to U.S. bonds, which unleashed $14 billion in net purchases over the past year, and a crackdown by mainland authorities on loosely regulated wealth management products, which helped fuel 50% growth for China's ETF market over the past year.

Those policy-driven cases "give the APAC region a distinct flavor" vis-a-vis ETF markets in the U.S. and Europe, noted Tyler Cloherty, senior manager and head of the knowledge center at money management consulting firm Casey Quirk, a practice of Deloitte Consulting LLP.

While similar regulatory openings can be seen in other markets — for example, insurance firms in the U.S. have moved into ETFs after they were classified recently as individual securities on insurers' balance sheets — they account for "a much smaller proportion of the overall market relative to what you see in APAC," said Mr. Cloherty.

Market veterans say local ETF providers have proven best placed to take advantage of the resulting demand for locally listed ETFs.

For example, Tokyo-based money management heavyweight Nomura Asset Management, with a 45% share of Japan's ETF market, has enjoyed heady growth as the Bank of Japan's policy-related ETF investments rose by $50 billion a year, to ¥26.6 trillion as of July 31 from ¥21.1 trillion the year before and ¥14.7 trillion the year before that.

Nomura's TOPIX Exchange Traded Fund had ¥9.3 trillion, or $86 billion, in assets as of July 31, up from $71 billion a year before and $48 billion as of July 31, 2017. The firm's Nikkei 225 Exchange Traded Fund, meanwhile, had ¥6.06 trillion, or $56 billion, in assets as of July 31, up from $52 billion and $42 billion the previous two years.

The two funds' combined assets of $142 billion come to 40% of Japan's region-topping ETF total of $355 billion.

Demand from Taiwanese insurers, meanwhile, has prompted a raft of new listings in Taipei of ETFs investing in U.S. credit, which have gathered assets. To name just a few, Taipei-based Cathay Securities Investment Trust Holding's Bloomberg Barclays U.S. Corporate A ETF, launched Nov. 30, boasts $1.2 billion in assets, while two funds launched in late January by Taipei-based CTBC Investments — the CTBC Bloomberg Barclays Banking 10-year ETF and the CTBC Bloomberg Barclays USD Corporate 10+ year High Grade Capped Bond ETF — have just less than $1 billion already.

And even with the launch of a new program in April allowing Japanese and Chinese investors to invest in ETFs listed in each other's markets, and the promise of a broader "ETF Connect" program between the mainland and Hong Kong over the coming year or two, China's $67.6 billion ETF market remains mostly closed to foreign managers for now.

Still, foreign managers say the region's market is far more attractive than its locally listed ETFs' 11% share of the $5.64 trillion global market might suggest — even if the opportunity is tough to quantify.

That's because the majority of ETF flows in the Asia-Pacific region "haven't gone into local products," they've gone into offshore products, said Sean Cunningham, Hong Kong-based head of Asia ETFs with J.P. Morgan Asset Management.

For institutional investors in Asia, locally listed ETFs are just part of their allocations, and a rather small part at that, agreed Christopher Friese, Hong Kong-based head of Lyxor ETF, Asia-Pacific. Their investment in ETFs is "huge" but not entirely visible because they invest the bulk of their money in ETFs listed overseas.

That willingness to invest in ETFs listed overseas stands in stark contrast to U.S. and European asset owners, who for the most part stick to their home markets, said Marco Montanari, Hong Kong-based managing director and head of passive asset management, Asia-Pacific, with DWS Group GmbH & Co.

According to estimates by DWS, Asia-Pacific institutional flows to ETFs listed outside of the region come to $150 billion.

Mr. Cunningham, who joined J.P. Morgan Asset Management in October 2018 to drive its ETF business in the region, said his firm is focusing — for now — on bringing its U.S. and European-listed ETFs to the growing army of institutional investors in the region looking to diversify their portfolios globally. It has no imminent plans to list ETFs on local exchanges, he added.

"There are opportunities for global products in every single market" in the region, said Mr. Cunningham.

In the Asia-Pacific region, the focus of BlackRock Inc., the world's biggest ETF provider with $2 trillion in assets as of June 30, is on "institutional segments as well as private banking," said Geir Espeskog, Hong Kong-based managing director and head of iShares distribution, Asia-Pacific, with the New York-based firm.

Insurers, asset managers, pension funds and sovereign wealth funds in the region have $120 billion invested now in iShares ETFs — of which 20% are listed on Asia-Pacific exchanges and 80% are listed elsewhere, said Mr. Espeskog. That total is up from $108 billion at the end of 2018 and $100 billion the year before.

Market veterans, meanwhile, say it's unclear how soon retail investors in the region could become significant contributors to ETF market growth.

But a stronger retail market, while welcome, isn't necessary for foreign firms to plant their flags in the region, noted DWS' Mr. Montanari. The growing ranks of insurers, pension funds and sovereign wealth funds using ETFs now would be a compelling reason to be in the region even if retail investors remain largely on the sidelines for the foreseeable future, he said.

Even excluding the BOJ's ETF allocations, last year's $56 billion in combined net inflows to Asia-Pacific-listed ETFs for the first time surpassed Europe's $53 billion in inflows, Mr. Friese said.

Meanwhile, the number of firms expanding their ETF operations in the region continues to grow.

Fidelity International is following a two-pronged strategy now to differentiate itself in a crowded market, said Nick King, the firm's head of ETFs, Asia-Pacific.

One leg of the strategy focuses on offering smart beta strategies benchmarked to indexes developed by Fidelity, such as a high-dividend ETF constructed to avoid the big overweight in utilities while offering more exposure to the tech sector. The other leg is focused on active ETF strategies.

Fidelity International launched its first active ETF in Australia in November, joining a growing pool of more than 20 products, said Mr. King. And while still early days, with A$25 million ($18 million) in assets, the product's returns of 25% are double the index's 12.5% gain — a performance Fidelity's team is very happy with, Mr. King said.

On July 30, however, the Australian regulator, the Australian Securities and Investments Commission, hit the pause button on the new and fast-growing active ETF sector there, suspending further listings while it considers "appropriate regulatory settings." That active segment has quickly grown to 6% of Australia's ETF market, according to an ASIC news release.