Can leveraged and inverse exchange-traded funds revive the market?

EXCHANGE-TRADED funds (ETFs) are one of the fastest-growing asset classes in the world, yet their growth in Malaysia has been extremely poor.

Globally, ETFs have never been doing better.

In fact, BlackRock calls it one of the most powerful investing trends of the century.

While the turn of the century started off with fewer than US$100bil in ETF assets, this had swelled to US$6.3 trillion as of end-2019. Investors piled in US$570bil into ETF assets in 2019 alone.

Global ETFs have grown at an organic annualised rate of 19% from 2009 through 2017, far outpacing the 4.8% growth rate for other open-end fund types.

For the uninitiated, ETFs are open-end index funds that can be bought or sold in real time, like a stock. ETFs combine the efficiency and simplicity of on-exchange trading with the merits of index-based investment strategies.

In its 2018 special report on the “Four Big Trends to Drive ETF Growth”, BlackRock said that ETFs were on course to potentially gather more assets over the next five years than in the previous 25 years combined.

Global ETF assets are poised to more than double, to US$12 trillion by the end of 2023, potentially even reaching US$25 trillion by end-2027.

Against such a robust global backdrop, surely this would provide some sort of boost to the Malaysian market.

Alas, the Malaysian ETF scene is a far cry from the booming global scenario.

No doubt ETFs in Malaysia only made their debut back in 2005. Perhaps, due to a lack of awareness and education, nobody really took ETFs as a serious asset class.

It was unpopular both among the public and institutional investors. A quick look at the 18 ETFs on Bursa Malaysia shows that most are illiquid, with some completely not traded for days.

In fact, as recent as end-2018, there were only 10 ETFs on Bursa.

To date, this has increased to 18, thanks to a new breed of ETFs that Bursa has introduced to the market – leveraged and inverse (L&I) ETFs.

Bursa feels L&I ETFs may be a catalyst for more traction into the ETF market.

In recent months, Bursa and participating organisations have beefed up their efforts by holding roadshows and educational briefings.

In November, Affin Hwang also listed four L&I ETFs.

There were two new L&I ETFs listed earlier this week by Kenanga Investors Bhd.

Whether or not L&I ETFs will be able to help grow the ETF market at a respectable pace, however, remains to be seen.

What are L&I ETFs?

In a briefing back in November, Bursa Malaysia vice-president of the product development securities market Mark Chan said that one of the key factors that contributed to the faster growth of the ETF market in Asia Pacific was the introduction of L&I ETFs.

This has been well received by Asian investors, particularly in Japan, South Korea and Taiwan.

Chong: What may be missing instead are sustained efforts to educate the investing public on what ETFs are and the benefits they offer.Chong: What may be missing instead are sustained efforts to educate the investing public on what ETFs are and the benefits they offer.

L&I ETFs were first introduced in the United States in 2006, and there are currently 819 ETFs listed globally.

Within Asia Pacific, the first leveraged ETF was listed in South Korea in 2009, and there are currently 227 L&I ETFs listed in the region.

A leveraged ETF aims to amplify the return of an index on a daily basis. The inverse ETF, meanwhile, is designed to provide returns that are the opposite of an index on a daily basis.

Thus, leveraged ETFs can produce the targeted multiple return of up to two times, while the inverse ETF can produce a targeted multiple return of (negative one times) of the benchmark on a daily basis, usually through financial derivatives.

If investors have a short-term view that the market is trending upwards, they may consider a leveraged ETF. This is because leveraged ETFs perform best when there is a clear upward trend over a short period.

Meanwhile, if investors expect a bigger drop or a temporary bear market, they can consider the inverse ETF. This is because inverse ETFs prosper when stock prices fall.

Via the leveraged ETF, investors can enjoy leverage without being provided any margin.

Affin Hwang Asset Management Bhd set the ball rolling with the launch of the country’s first L&I ETF in November 2019.

The company announced the simultaneous listing of four ETFs on Bursa (two leveraged and two inverse ETFs), providing investors the opportunity to profit from both bull and bear market trends.

On Jan 13, Kenanga Investors announced the listing of OneETF by Kenanga on the Main Market of Bursa, signalling the company’s first foray into ETFs by means of L&I ETFs.

What ails the ETF market?

Affin Hwang Asset Management director of innovation lab and alternative Investment Chong Lee Choo says that the explosive growth of ETFs amounting to over US$6 trillion mostly came from developed markets like the US and Europe.

“While the passive investing wave is catching on in Asia, especially in markets like South Korea and Hong Kong, Malaysia seems to be still lagging behind its regional peers.

“Despite debuting its first ETF almost 15 years ago in 2005, the market only has 18 listed ETFs on Bursa Malaysia year to date. Trading volumes have also floundered through the years, with total volumes growing slightly over 13% since a decade ago, ” says Chong.

“In a way, the lack of retail interest shown in ETFs has created a vicious cycle that is stunting industry growth. The low participation seen from the retail segment has become a deterrent to ETF issuers when looking to list new ETFs, ” says Chong.

Kenanga Investors director and chief executive officer Ismitz Matthew De Alwis says that there are various reasons why ETFs haven’t really taken off in Malaysia.

“On a positive note, our market has been vibrant in the last decade and the KLCI has been appreciating ever since its steady recovery from the financial crisis of 2008.

“This has led to both retail and institutional investors preferring direct exposure of the underlying components of the index and the preference for liquid stocks to partake in trading in the market.

“This is coupled with the lack of liquidity and market makers in the ETF industry, as well as a lack of attractive local ETF offerings which are deemed to be less unique or generally passive (or assumed index trackers).

“Also, many prefer to purchase ETFs from markets which are generally hard to gain direct exposure to, for example, India and China, ” says De Alwis.

On top of that, De Alwis notices that when an ETF is introduced to the market when the market is not performing, investors are inclined to associate this as an ETF’s general performance.

“Therefore, it is easy for an investor to assume that ETFs are always performing badly. But when used correctly, ETFs, especially L&I ETFs, can potentially be used to mitigate these exact downturn risks, or bolster the returns derived from a burgeoning market. Investors need to understand this before coming to an inaccurate conclusion.

“It would be a shame for many qualified investors if they refuse to learn more about the benefits that ETFs bring, ” explains De Alwis.

At the same time, Chong says that the poor breadth of product offerings cannot attract sufficient interest from investors.

Misconceptions about the lack of liquidity in the domestic ETF market are also hindering its growth despite the presence of market makers.

“However, shifting preferences are taking root with a new generation of investors becoming more empowered to utilise technology and information when making portfolio allocation decisions, ” says Chong.

These include their attention to costs as a factor to overall performance and their demand for value in spite of it.

Robo-advisory platforms have deftly capitalised on this trend to offer customised portfolios that are ironically composed of ETFs.

So, it’s not a lack of interest that is hampering the growth of the industry because there is demand.

“What may be missing instead are sustained efforts to educate the investing public on what ETFs are and the benefits they offer.

“Besides its low-cost advantage, ETFs provide an avenue for investors to quickly gain market exposure and diversify efficiently, effectively and easily, ” says Chong.

Chong adds that it is even more important to sustain the momentum and educate investors on how they can employ such strategies in a portfolio.

“With a broader range of innovative ETF offerings listed on the local exchange through an enhanced product framework, we believe that investors will increasingly employ them as building blocks in a portfolio.”

De Alwis says that generally, the market needs greater investor participation and to enhance the ecosystem and promote more inclusive participation in the Malaysian capital market for ETFs, for increased product innovation and to provide affordable entry points for retailers in traditionally difficult–to-access investments.

“We still need time before we can see some actual growth since the implemented changes were only recently introduced. The development of the ETF market faces hurdles, but has massive potential.

“Also, we need to be mindful of technological advances which will increase investment choices in general, not just ETFs, and change investor behaviour. I think that these alternative platforms, whether you call them direct indexing or not, are the future of consolidated investment management, ” says De Alwis.

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