China, a latecomer to ETFs, holds great promise

3gzylon 2014-04-08

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2014-04-08 09:38 Shanghai Daily Web Editor: qindexing

Exchange-traded funds (ETFs) in China's mainland have been one of the fastest-growing products since they were first introduced here in 2005. As of the end of March, there were 81 ETFs listed on the Shanghai and Shenzhen stock exchanges.

China's ETF market, despite its late start, will develop in the same way as mature markets as deregulation progresses, according to John Davies, vice president of the Global Exchange Traded Products at S&P Dow Jones Indices.

Last year, S&P Dow Jones Indices tied up with Bosera Asset Management to launch the first S&P 500-based ETF in China, adding channels for Chinese investors to tap into the US market.

Globally, there are US$655 billion of ETF assets tracking S&P Dow Jones Indices, representing a 29 percent share of the ETF market, according to Davies.

He heads the global team for ETF licensing and plays a key role in the development of S&P Dow Jones Indices. He also manages relationships between S&P Dow Jones Indices and its ETF partners globally.

Davies sat down with Shanghai Daily to discuss China's ETF market.

Q. What are your criteria for selecting local sponsors in China?

A: We look at a number of things. We look at their strengths in the local market in terms of their products, their distribution capabilities and their capacity to work with us. Obviously, it's a partnership. We want to work with people we can complement. We want to work with ETF sponsors to try to educate clients and on index design and structure.

In more mature markets, we work with multiple ETF sponsors who may have competing products. In China, a new market, we are engaging more and more ETF issuers to increase our product reach and brand awareness.

Q: MSCI Inc announced earlier that it's going to include a fraction of China A shares in its widely traded emerging market index. Does S&P Dow Jones have any similar plan to include A shares in its indices?

A: MSCI's announcement was more about consultation with their clients. This is the right way to bring A shares into their standard indices. Most index providers carry out what's called "countries classification review." We do the same. We review markets to see whether they can be elevated from frontier status to emerging market status and to developed status. That's a continuing process.

With regard to China specifically, we recently created the S&P Total China BMI Indices. They include both A shares and offshore listings. So we already have an index infrastructure that includes A shares. We're actively talking with clients about using that index. Going forward, we will review the A-share market to see whether it should be brought into a broader index. That's an ongoing review.

Q: When you talk about reviewing the A-share market, what specifically do you look at?

A: There is a whole list of different factors. It's not just the shares themselves. It's about market infrastructure. It includes capital controls on currencies, taxation and the regulatory environment. All of those factors are reviewed to see whether a particular market is fully accessible to international investors.

Q: China launched its first two gold-backed ETFs last year. However, they raised less than the expected funds. It seems investors prefer physical gold to ETFs. What do you think?

A: Gold is an interesting commodity. Some people view it as a commodity like oil or wheat; others view it as a financial asset. Some investors like to hold physical gold, while others are quite happy to use futures or ETFs. I think it is down to individual investor profiles.

India is another example where gold is a very popular investment for cultural reasons. If you look at the ETF market in India, it is dominated by gold ETFs. One of them is actually now creating a structure where you can take physical delivery of a small quantity of the metal.

Gold is one of those things that drive some people to want to possess it tightly. Either they want to open the vault and see the gold bars, or they are just happy to look at their investment status in an ETF.

I don't think it has anything to do with product structures. It's down to investors' preference. If you look at institutional investors in Western markets, they use gold as an inflation hedge. While in India, it's a sign of wealth. Different views in different markets.

Q: What trends have you observed in China's ETF market?

A: I think gold ETFs launched last year are an interesting development. First there were standard products looking at broader markets, but now there are products looking at sectors. That's quite innovative in the early stages of an ETF market. It took the US a long, long time to cover the gold ETF market.

The global ETF market is 21 years old. It's not an overnight success. It has taken time to get to the stage where it is now. The same will apply to China. It's not going to happen overnight. But looking at matured markets, they should keep the faith that this market will develop in the same way.

Q: What will be the key issues driving the development of China's ETF market?

A: The issue is to carry on doing product development as investors become more educated about what ETFs can do.

As a market develops, investor appetite increases. They start to look at portfolio construction, portfolio allocation and investing outside their home markets. In response, providers should issue more products to cater to those demands.

And, obviously, the liberalization of the local market will help enormously. That obviously is moving in the right direction, with the quotas programs being expanded and allowing international listings of A-share products. It's all positive.

Q: For your company, what are the challenges in China?

A: This is China. It's the same with other emerging economies. We've got operations in India, Africa and South America. They all have very similar situations in terms of local markets evolving and opening. As part of that process, there has to be the liberalization of regulations.

So the challenge for us is to make sure that we're fully aware of the impact of those regulations and their evolution, and to make sure that we engage with local regulators, local exchanges and local asset management companies. We're on top of what's going on. So we can make sure that we have products that are relevant to local markets.

Q: Understanding benchmarks is quite important for ETF investors. What would be your advice for Chinese ETF investors?

A: I think the responsibility lies with index providers and ETF sponsors to educate investors about what they're actually buying.

People have to understand the structure of the products and what they're actually getting exposed to. There have been some examples in Europe and in the US where clients bought spot-based ETFs or leveraged ETFs. But they didn't fully understand the implications of buying these types of products. As a result, there are negative crises. It's an example of people buying things they didn't fully understand. I think ETF providers have taken note from that and have increased their outreach to clients to explain how the products work.

From an indices provider's perspective, we do exactly the same.

Our indices are fully transparent, the methodology is public and all the information is available on our website. We do road shows with ETF sponsors and investment banks to talk about how the indices work. Our research people, product people and sales people all regularly speak to clients about how our indices work.