More than simply tracking the market. A guide to passive fund management. For professional clients only

Transcription

1 More than simply tracking the market A guide to passive fund management For professional clients only

2 Over recent years, there has been a rapid growth in inflows into passive investments, such as index tracker funds and Exchange Traded Funds (ETFs). Passive funds aim to offer investors lowcost, diversified and transparent market access. The goal of passively-managed funds is to track a benchmark index, which usually represents a broad market or a segment within that market. However, the day-to-day management of passive funds goes beyond merely buying and holding the underlying securities. These daily tasks range from managing corporate actions and dividend cash flows to implementing index rebalances. This document sets out the key responsibilities of passive fund managers and how they run their portfolios on a day-to-day basis to ensure that they track their benchmark in the most efficient way possible. Introduction 3 Building a passive fund 4 What should I look for in a passive 6 fund provider? Why choose HSBC Global 8 Asset Management Important Information 11 2 More than simply tracking the market

3 Introduction The challenging market environment of recent years has led to many investors moving into passive funds, as they seek more cost-efficient market access. Rising global demand for passive investments has led to the development of a wide range of passive funds, covering a broad spectrum of market areas, sectors and asset classes. We expect investor demand for passive solutions to continue growing, both as a result of recent regulatory changes (such as those brought in by the Retail Distribution Review) and rising interest in passive investments from investors looking to reduce the cost of managing their investment portfolios. Subsequently, we believe that passive funds are likely to play a greater role in the core of investor portfolios over the coming years. The many roles of the passive fund manager As with any investment, the knowledge and experience of the individual fund manager play a key role in the successful running of a passive fund. Passive fund managers have to be able to handle proprietary research and in-house models to make their own informed decisions about the most efficient way to manage cash flows and other corporate actions (such as index rebalancing and dividends). At the same time, managers ensure that the risk profile of their fund remains within the established limits compared to the underlying benchmark. During falling and difficult markets, the ability of a fund manager to navigate these challenging market conditions becomes crucial for the performance of the fund. As such, passive fund managers have a variety of dynamic operational roles to play in managing their investors money. More than simply tracking the market 3

4 Building a passive fund HSBC Global Asset Management s range of passive funds is based on a robust investment process. We start with what we call the universe analysis of the underlying index, focusing mainly on FX allocation, rebalancing costs, dividends and taxes. While defining the indexation methodology, we consider client-specific requirements in relation to the constraints of the fund. The objective of this exercise is to minimise tracking error as much as possible. In order to decide on portfolio construction, we then look at the investable universe with respect to liquidity, volume, index turnover and volatility, as well as the distribution between large and small cap stocks within it and its composition at the country, sector and industry level. A matrix approach is then used to manage factor risk in the portfolio and to ensure that it has a neutral position relative to the risk exposure implied by the benchmark. We then carry out pre- and post- trading analysis to ensure that our portfolio is implemented in the most pragmatic and effective way. Another part of this trading analysis, which is aimed at minimising costs, is to estimate the actual costs, whether they are explicit (taxes, custodian and execution) or implicit (market impact). Continuous fund monitoring After the launch of a fund, and throughout its life, passive fund managers continuously monitor and analyse their portfolios, to ensure that the fund closely tracks its benchmark. The cost and risk management activities undertaken by passive fund managers on an ongoing basis in the management of their portfolios are outlined below. Cost Management The objective of a passive investment fund is to replicate the performance of its benchmark index. However, the costs of managing the fund will most likely prevent it from delivering the exact benchmark return. This is because, unlike the fund, the index itself does not incur any trading costs when it rebalances. In practice, costs play a key role in determining portfolio performance. Passive fund managers concentrate on minimising the impact of a range of factors that drive fund costs, and subsequently the fund s tracking difference to the benchmark. Key cost considerations include: Index rebalancing When an index rebalances (i.e. when it goes through regular review of its composition and constituent weights), passive portfolio managers also need to rebalance the funds tracking that particular index accordingly. They will therefore buy and sell securities, so that the fund matches the new composition of the benchmark. However, buying and selling equities involves trading costs, which will have an impact on the passive fund s performance relative to the index. Corporate actions Corporate actions (such as mergers and acquisitions, stock splits, rights issues, spin-offs or the receipt of interest/ dividends) also need to be processed by a passive fund manager, which may then generate trading costs or other implicit costs related to the corporate activity in the underlying investment. For example, dividends paid by the underlying stocks of a passive fund need to be reinvested, as keeping them in the portfolio would create a cash drag. This refers to the impact on the fund s performance from being underexposed compared to its benchmark due to cash accumulation. Taxation Taxation can also add to the difference between the performance of a passive fund and that of its benchmark. A common example of such a difference would be the 4 More than simply tracking the market

5 withholding tax (WHT) rate paid on dividends. An index might assume that the tax rate on a stock s dividend is 30% for a given country, while the fund, as a result of a favourable tax treaty between the stock s country and the fund s domicile country, might actually only pay a 15% tax rate. The reverse is also possible and, in some instances, the fund might pay a higher WHT rate than that assumed by the index. Risk management Comprehensive risk management also forms a crucial part of the passive fund manager s role. This is not only key during the portfolio construction process, but continues on an ongoing basis over the life of the fund. Passive fund managers carry out risk management analysis on a daily basis. This starts with the verification of the net asset value and performance attribution, which allows them to monitor how closely the fund is tracking its benchmark. Other factors, such as the fund s current exposure to foreign currency, sectors or countries, are also taken into account. In addition, risk management monitoring considers the impact of the treatment of corporate actions, index rebalancings and exchange rate movements. This is done on an on-going basis. Passive fund managers also need to be aware of changes to the taxation or regulatory environment, to see what impact these might have on fund performance. When considering global portfolios, this includes keeping track of potential changes across several regulatory regimes at once. At a trading level, fund managers have to be aware of all the different market holidays that occur around the world and how these are handled by index providers, as well as the specific trading and settlement rules on each exchange. A growing passive product range Over the past 25 years, there has been a significant increase in the scale and scope of passive investment products available to investors. The first widely-used passive investment product was the index tracker fund, which came to prominence in the 1980s and 1990s. The next stage in passive investment in Europe was represented by the emergence of Exchange Traded Funds (ETFs) during the 2000s. ETFs added liquidity and transparency to the index trackers core strengths of cost-effective and diversified market access. At present, a growing range of smart beta solutions, such as HSBC Alternative Indexation or RAFI*, is being pioneered by many passive fund managers. Smart beta uses quantitative analysis or other proprietary research to come up with alternative investment strategies. These include using alternative weighting methods to the traditional market capitalisation approach, or constructing new alternative market capitalisation based indices that have a stronger grounding in actual economic fundamentals. Other methods of gaining index exposure include segregated mandates. Individual circumstances (such as tax eligibility or any client restrictions) can help advisors to decide which type of passive investment product is right for their clients specific needs. * In partnership with FTSE, Research Affiliates (RA) launched a series of indices based on the Fundamental Index (FI) methodology developed by Research Affiliates. More than simply tracking the market 5

6 What should I look for in a passive fund provider? There are several key factors to consider when choosing the right passive fund provider for your clients investment needs. These include: Experience Scale Index methodology Tracking performance Costs Commitment to innovation Experience As with any investment decision, it is worth seeking out fund managers that have a long track record in managing passive investments if you are seeking to invest in a passive product. Many leading fund managers, including HSBC Global Asset Management, now offer over 25 years experience in managing passive investments. Scale Larger passive fund managers are able to achieve greater economies of scale, which can lead to lower costs for clients. Global passive fund managers also need to maintain and develop relationships with traders and brokers around the world, to ensure best execution and low trading costs. It is also in passive fund managers interests to have a local presence in key global trading centres, so they can keep up to date with changing regulations and understand exactly how local markets work. HSBC Global Asset Management has extensive expertise and a long track record in both developed and emerging markets and we can offer direct market access on many local stock exchanges. We are therefore able to go further than other providers in offering full physical replicated passive investment products. This long experience also supports our aim to keep down our costs, which helps to both minimise fees and maintain a strong tracking performance. Index methodology There are several ways to construct a passive fund. HSBC Global Asset Management believes that the full physical replication approach to passive fund construction (i.e. buying all of the stocks in the underlying index and in the same proportion as the index) is the best approach to take, as it allows us to construct funds with a high degree of transparency and simplicity. Where it is not cost-effective to buy all of the securities in the underlying index (e.g. for broad indices such as the FTSE All-Share or the MSCI World), we use a process known as optimisation, where we own a proportion of securities in the underlying index. Although some studies have shown that synthetic funds (which use swaps and other derivative products to obtain market access) can offer a lower tracking error over time than full physical replicated funds, we believe that the risks associated with such synthetic funds the most important of which is counterparty risk make them a less attractive investment option. Moreover, it is not always the case that synthetic funds provide clear outperformance when compared to physical funds. For example, HSBC Global Asset Management has developed a range of physical ETFs (notably in Russia and Emerging Markets) that offer very competitive tracking performance compared to rival synthetic funds. This has been achieved by leveraging our local expertise in these markets, enabling us to carry out direct investment in local stocks wherever possible. This helps to reduce the tracking error of our funds. Tracking performance As we stated above, the full replication element to HSBC Global Asset Management s investment approach reduces the potential for any significant divergence in tracking performance. When deciding upon any investment in a passive fund, it is crucial to consider its historic tracking performance. In doing so, it is worth looking at both tracking difference (the difference between the net asset value of a fund and its benchmark) and tracking error (how consistent this return difference has been over time, computed using the standard deviation of the tracking difference). If, over time, the tracking error of a passive fund relative to its benchmark index increases disproportionately, the return objective of the overall investment portfolio would not be met. Consequently, HSBC Global Asset Management s replication approach across its range of passive investment products aims to minimise tracking error as far as possible. A low tracking error means that a passive fund is meeting its main investment objective, namely matching the returns of its benchmark closely. 6 More than simply tracking the market

7 Costs A commitment to competitive costs is essential for a passive fund manager. Passive investments such as index trackers and ETFs have historically tended to have lower costs than active funds. This reflects the fact that passive funds do not require large teams of active managers or stock-pickers to generate outperformance, as the objective of a passive fund is only to match the performance of its benchmark. The key measurement of cost for both ETFs and index tracker funds is the Ongoing Charges Figure (OCF). The OCF incorporates elements such as the annual management fee and a list of other operating costs carried by the asset manager; these include administration, custody, trustee and audit fees, as well as legal, regulatory and registration expenses. On the other hand, corporate actions and index rebalancing - which both generate trading costs - are not included in that figure. There are also entry/exit fees to consider for index-tracker funds and trading spreads and brokerage fees for ETF investments. HSBC Global Asset Management is able to use its global footprint and existing local expertise to devise cost-effective passive investment products that offer a range of market exposures, from global down to country-specific. Within emerging markets, our trading scale often enables us to negotiate attractive dealing costs on local exchanges, which we can then pass on to investors via lower OCFs. Our passive investment team is also able to call upon the full infrastructure and expertise of the wider HSBC group in areas such as global banking and markets, through to custodian and administrative services. Moreover, our integrated IT systems help us to achieve efficient execution and portfolio management. Commitment to innovation Passive investments are currently experiencing a period of rapid growth, with more and more fund managers looking to leverage their own proprietary research to develop new smart beta investment solutions. A commitment to innovation is therefore another key strength that you should consider when choosing a passive investment partner. HSBC Global Asset Management remains committed to innovation in smart beta and we have now enhanced our passive range by offering investors Alternative Indexation solutions. Alternative Indexation offers a complementary option to commonly used benchmarks, whereby we use our own proprietary research to develop traditional or alternative weighting schemes. More than simply tracking the market 7

8 Passive Investmen Why choose HSBC Global Asset Management? HSBC Global Asset Management s range of passive investment products (index tracker funds, ETFs and Alternative Indexation) has been designed with the investor in mind. To that end, we have used our global presence to create a broad range of passive funds across both developed and emerging markets that provide exposures to the areas where our clients are looking to invest. HSBC Global Asset Management is a leading global investment manager with a long track record of providing sound investment solutions to a wide range of investors around the world. We have been managing passive investments for over 25 years. The fact that we have a common investment management team working across our global passive range ensures that portfolio construction and risk management processes are consistent across our range of products. HSBC Global Asset Management also believes in high levels of transparency across its range of passive investment products. We provide a daily list of the securities held by each fund (portfolio composition file) as well as monthly fund factsheets. Moreover, our overall investment approach remains conservative. We believe in strong levels of risk management and governance for our passive funds, aiming to deliver minimum tracking error at a competitive price to our clients. We believe that HSBC Global Asset Management is now well placed to take a leading position in passive investment, offering investors a broad range of complementary passive investment solutions that can work alongside the active portions of client portfolios. HSBC Global Asset Management has a long track record in emerging market investment and we can subsequently offer direct market access on many local stock exchanges. We are therefore able to go further in offering passive funds based on this fast-growing market sector than other providers. HSBC Global Asset Management s robust quantitative portfolio management and trading processes ensure that our funds are able to track their benchmark indices closely. HSBC Global Asset Management Index Tracker Funds range HSBC AMERICAN INDEX FUND HSBC FTSE 100 INDEX FUND HSBC FTSE 250 INDEX FUND HSBC FTSE ALL SHARE INDEX FUND HSBC EUROPEAN INDEX FUND HSBC JAPAN INDEX FUND HSBC PACIFIC INDEX FUND HSBC UK GILT INDEX FUND 8 More than simply tracking the market

9 What to consider when investing in an index tracker fund and an ETF Market risk The value of investments and any income from them can go down as well as up, and investors may not get back the amount originally invested. Currency risk Where overseas investments are held, the rate of currency exchange may cause the value of such investments to go down as well as up. Emerging market risk Investments in emerging markets are by their nature higher risk and potentially more volatile than those inherent in some established markets. Geographic risk Some of the Index tracker Funds and Exchange Traded Funds invest predominantly in one geographic area; therefore any decline in the economy of this area may affect the prices and value of the underlying assets. Property risk The value of interests in real estate companies may be affected by changes in interest rates, tax laws and environmental laws and regulations. While the value of interests in REITs may be affected by the value of the property owned or the quality of the mortgages held by the trust. Russian risk There are significant risks inherent in investing in Russia, which could affect the value of investment. These include a lack of clarity in laws and regulations in the following areas: investor protection, banks and other financial services, the Russian economic system, taxation, transaction settlement and fiduciary duty and responsibilities of company management. Please see the supplement for full information. Investors and potential investors should read the relevant Key Investor Information Document (KIID) and full prospectus and supplement for full details of the risks involves prior to making a decision to invest. If you have any doubt about the suitability of an investment you should consult a financial adviser. t Product Overview Exchange Traded Funds range HSBC ESI WORLDWIDE EQUITY UCITS ETF HSBC EURO STOXX 50 UCITS HSBC FTSE 100 UCITS HSBC FTSE 250 UCITS HSBC FTSE EPRA/NAREIT DEVELOPED UCITS HSBC MSCI AC FAR EAST ex JAPAN UCITS HSBC MSCI BRAZIL UCITS HSBC MSCI CANADA UCITS HSBC MSCI CHINA UCITS HSBC MSCI EMERGING MARKETS FAR EAST UCITS HSBC MSCI EMERGING MARKETS LATIN AMERICA UCITS HSBC MSCI EMERGING MARKETS UCITS HSBC MSCI EUROPE UCITS HSBC MSCI INDONESIA UCITS HSBC MSCI JAPAN UCITS HSBC MSCI KOREA UCITS HSBC MSCI MALAYSIA UCITS HSBC MSCI MEXICO CAPPED UCITS HSBC MSCI PACIFIC ex JAPAN UCITS HSBC MSCI RUSSIA CAPPED UCITS HSBC MSCI SOUTH AFRICA UCITS HSBC MSCI TAIWAN UCITS HSBC MSCI TURKEY UCITS HSBC MSCI USA UCITS HSBC MSCI WORLD UCITS HSBC S&P 500 UCITS HSBC S&P BRIC 40 UCITS HSBC WORLDWIDE EQUITY UCITS ETF More than simply tracking the market 9

10 Important Information This document is intended for professional clients only and should not be distributed to or relied upon by retail clients. The material contained herein is for information purposes only and does not constitute investment advice or a recommendation to any reader of this material to buy or sell investments. Care has been taken to ensure the accuracy of this document, but HSBC Global Asset Management (UK) Limited accepts no responsibility for any errors or omissions contained therein. Fund information The HSBC index tracker funds referred to are sub-funds of HSBC Index Tracker Investment Funds, an Open Ended Investment Company that is authorised in the UK by the Financial Conduct Authority. The Authorised Corporate Director and Investment Manager is HSBC Global Asset Management (UK) Limited. HSBC ETFs are sub-funds of HSBC ETFs plc, an investment company with variable capital and segregated liability between sub-funds, incorporated in Ireland as a public limited company, and authorised by the Central Bank of Ireland. The company is constituted as an umbrella fund, with segregated liability between sub-funds. Shares purchased on the secondary market cannot usually be sold directly back to the Company. Investors must buy and sell shares on the secondary market with the assistance of an intermediary (e.g. a stockbroker) and may incur fees for doing so. In addition, investors may pay more than the current Net Asset Value per share when buying shares and may receive less than the current Net Asset Value per Share when selling them. For investors in the UK All applications are made on the basis of the current HSBC ETFs plc Prospectus, relevant Key Investor Information Document ( KIID ), Supplementary Information Document (SID) and Fund supplement, and most recent annual and semi-annual reports, which can be obtained upon request free of charge from HSBC Global Asset Management (UK) Limited, 8 Canada Square, Canary Wharf, London, E14 5HQ. UK, or from a stockbroker or financial adviser. Investors and potential investors should read and note the risk warnings in the prospectus, relevant KIID, SID and Fund supplement. UK-based investors in HSBC ETFs plc are advised that they may not be afforded some of the protections conveyed by the Financial Services and Markets Act (2000), ( the Act ). The company is recognised in the United Kingdom by the Financial Conduct Authority under section 264 of the Act. Restrictions The shares in HSBC ETFs plc have not been and will not be offered for sale or sold in the United States of America, its territories or possessions and all areas subject to its jurisdiction, or to United States persons. Affiliated companies of HSBC Global Asset Management (UK) Limited may make markets in HSBC ETFs plc. Index disclaimer The EURO STOXX 50 is the intellectual property (including registered trademarks) of Stoxx Limited, Zurich, Switzerland and/or Dow Jones & Company, Inc., a Delaware corporation, New York, USA, (the Licensors ), which is used under license. The securities based on the Index are in no way sponsored, endorsed, sold or promoted by the Licensors and neither of the Licensors shall have any liability with respect thereto. All rights in the FTSE 100 and the FTSE 250 (the Indices ) vest in FTSE International Limited ( FTSE ). FTSE is a trademark of London Stock Exchange Group companies and is used by FTSE under licence. The HSBC FTSE 100 UCITS ETF and the HSBC FTSE 250 UCITS ETF (the Products ) have been developed solely by HSBC Global Asset Management (UK) Limited. The Indices are calculated by FTSE or its agent. FTSE and its licensors are not connected to and do not sponsor, advise, recommend, endorse or promote the Products and do not accept any liability whatsoever to any person arising out of (a) the use of, reliance on or any error in the Indices or (b) investment in or operation of the Products. FTSE makes no claim, prediction, warranty or representation either as to the results to be obtained from the Products or the suitability of the Indices for the purpose to which they are being put by HSBC Global Asset Management (UK) Limited. 10 More than simply tracking the market

11 FTSE is a trade mark of the London Stock Exchange Group companies, NAREIT is a trade mark of the National Association of Real Estate Investment Trusts ( NAREIT ) and EPRA is a trade mark of the European Public Real Estate Association ( EPRA ) and all are used by FTSE International Limited ( FTSE ) under licence). The FTSE EPRA/NAREIT Developed Index is calculated by FTSE. Neither FTSE, Euronext N.V., NAREIT nor EPRA sponsor, endorse or promote this product and are not in any way connected to it and do not accept any liability. The funds or securities referred to herein are not sponsored, endorsed, or promoted by MSCI, and MSCI bears no liability with respect to any such funds or securities or any index on which such funds or securities are based. The Supplement to the Prospectus contains a more detailed description of the limited relationship MSCI has with HSBC ETFs plc and any related funds. Standard & Poor s and S&P are registered trademarks of Standard & Poor s Financial Services LLC ( S&P ) and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC ( Dow Jones ) and have been licensed for use by S&P Dow Jones Indices LLC and sublicensed for certain purposes by HSBC Global Asset Management (UK) Limited. The S&P 500 and the S&P BRIC 40 are products of S&P Dow Jones Indices LLC, and have been licensed for use by HSBC Global Asset Management (UK) Limited. HSBC Global Asset Management (UK) Limited s HSBC S&P 500 UCITS ETF and HSBC S&P BRIC 40 UCITS ETF are not sponsored, endorsed, sold or promoted by S&P Dow Jones Indices LLC, Dow Jones, S&P, their respective affiliates, and neither S&P Dow Jones Indices LLC, Dow Jones, S&P, their respective affiliates make any representation regarding the advisability of investing in such product(s). Asset Management Ltd maintains a Conflicts of Interest policy to manage any conflicts of interest between HSBC Global Asset Management Ltd and other members of the HSBC Group or other affiliates. As the Index Sponsor, HSBC Global Asset Management Ltd has policies and procedures in place to ensure that it operates with transparency and accuracy in the Index creation and management process. This document is approved for issue in the UK by HSBC Global Asset Management (UK) Limited who are authorised and regulated by the Financial Conduct Authority. Copyright HSBC Global Asset Management (UK) Limited All rights reserved. To help improve our services and in the interests of security, we may record and/or monitor your communications with us. HSBC Global Asset Management (UK) Limited provides information to institutions, professional advisers and their clients on the investment products and services of the HSBC Group /AS/1014/FP Expiry 10/10/2015. HSBC Global Asset Management Ltd is the Sponsor for HSBC Economic Scale Index - Worldwide and HSBC Worldwide Index. As such, it maintains a segregation of duties from entities acting as the calculation agent for the Index, and investment manager for any products linked to this Index. HSBC Global More than simply tracking the market 11

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16 Contact For more information, please contact us: Telephone: +44 (0) Website: /14