Wave of the future: How ETFs and other listed products are poised to change the APAC investment landscape

Wave of the future: How ETFs and other listed products are poised to change the APAC investment landscape One of the global trends that PwC sees shaping the Asset and Wealth Management ( AWM ) industry through to 2025 is the rise of passive investing. 1 As investors challenge established fee models and demand greater returns on their investments in their pursuit of alpha, active and passive managers worldwide will need to respond accordingly and with increasing rapidity. Indeed, recent research on the fees charged by hedge funds indicate that investors only receive 48% of alpha generated, with the rest going towards the hedge fund manager in the form of fees. 2 If even sophisticated institutional investors are being challenged in determining whether or not they are paying for beta masked as alpha and reflected so in the fees they pay, what chance do individual investors have of finding a reasonable return on their investments at affordable fees? Accordingly, whether achieved through mobile distribution platforms, robo-advisors, or traditional asset managers, passive investing is set to greatly increase access to funds for billions of people across the globe and help lower the costs involved. Within the passive investment product universe, Exchange Traded Funds ( ETFs ) are likely to play a crucial role in this changing global landscape, not least across Asia-Pacific ( APAC ). Global ETF landscape and APAC focus As of May 2018, the global ETF market reached AUM of USD 4.7tr. The majority of this was concentrated in the USA with AUM of USD 3.5tr. Europe and APAC followed with AUM of USD 0.8tr and USD 0.5tr respectively. Within APAC, Japan holds the largest ETF AUM USD 308bn as of May 2018 with China and Hong Kong the next two largest markets with ETF AUM of USD 80bn and USD 40bn respectively. 3 1 For further information on the trends PwC sees as shaping the AWM industry globally, please refer to our report Asset and Wealth Management Revolution available here. 2 http://www.allaboutalpha.com/blog/2017/11/27/how-much-of-your-alpha-do-you-pay-awayto-your-hedge-fund-managers/ 3 Morningstar

Chart 1 APAC ETF AUM breakdown 100% 90% 80% USD 22bn USD 20bn USD 35bn USD 40bn 70% 60% 50% 40% 30% 20% 10% 0% USD 80bn USD 308bn Japan China Hong Kong Korea Australia Rest of APAC Globally, the top three players in the ETF market account for 81.52% of the global market. Despite this dominance and concentration, there is a very long tail in the global ETF landscape and niche managers can operate in specific markets or across targeted strategies. Within APAC, the market is a lot more fragmented and local players tend to dominate their home markets. Accordingly, the top three players hold approximately 31% of APAC ETF AUM, while the top five and top 10 hold 43% and 57% respectively. 4 Idiosyncrasies abound across the region, Japan with its vastly higher ETF AUM is home to the top three ETF managers, while Hong Kong and Singapore have a more international blend of players. The fragmented ETF landscape across APAC may be a cause or result of the relative unpopularity of ETF products as demonstrated by the lack of ETF AUM compared to the USA or Europe. Source: Bloomberg, PwC Chart 2 APAC ETF largest funds 80 71.02 70 USD (Bn) 60 50 40 30 51.85 34.25 31.24 26.61 23.20 Only two funds in APAC s top-10 largest ETFs are not managed by Japanese asset managers 20 10 17.44 12.48 12.25 9.11 0 Nomura TOPIX Exchange Traded Fund Nomura Nikkei 225 Exchange Traded Fund Daiwa ETF-TOPIX Nikko Listed Index Fund TOPIX Nikko Listed Index Fund 225 Daiwa ETF - Nikkei 225 Fortune SG Listed Money Market Fund Mitsubishi MAXIS NIKKEI225 ETF State Street Tracker Fund of Hong Kong Mitsubishi MAXIS TOPIX ETF Source: Bloomberg, PwC 4 Ibid. PwC 2

This relative unpopularity could be due to several reasons: Lack of retail investor attraction the main users of ETFs in APAC are institutional investors and individual investors are estimated to hold less than 15% of ETF AUM. As regulators across the region embrace roboadvisory services and become more open to FinTech solutions, enabling mass-retail investors to have greater ease of access to a wider range of investment products, ETFs should be well-positioned to move into this space. Lack of regulatory support ensuring that regulators support both ETF product creators and ETF investors will be crucial to their success. While fund passporting initiatives are not conducive to listed products, cross-border programmes like the ETF Connect scheme between China and Hong Kong can grant greater access to ETF products to investors and incentivise ETF product creators to launch new products in the market. Accordingly, we encourage regulators to watch the progress of the ETF Connect scheme and take steps to adapt similar initiatives across the region to build and improve upon it. Focus on equities among APAC investors The overwhelming majority of ETFs across APAC are equityfocussed which mirrors the strong equity focus found across APAC investors no matter their level of wealth. Encouraging a greater range of products across the region like fixed-income and thematic ETFs could go a long way to reducing this equity obsession, and new market strategies like Smart Beta, combined with the overall lower-costs of ETF products, should contribute to wean APAC investors off their equity ETFs. Despite these factors, sentiment for the future growth prospects of ETF products is high. Previous PwC reports estimated global ETF AUM would reach USD 7tr by 2021, with APAC ETF AUM amounting to USD 560bn. Given current growth rates, APAC should surpass that amount well before 2021 as ETF AUM has more than tripled since 2012. 5 Trends among other listed products Listed Mutual Funds ( LMFs ), Listed Investment Vehicles ( LIVs ), or Listed Investment Trusts ( LITs ) as they are sometimes referred to, are closed-ended, pooled investment vehicles which trade on exchanges. Relatively unknown across APAC in Australia, there were less than 12 LITs with market capitalisation of circa USD 450million as of August 2017 their nature makes them share similarities and differences with ETFs and unit trusts; they nearly always trade at a premium or discount to their net tangible assets depending on demand, similar to ETFs, they incur brokerage fees, and some LMF managers in Australia have offered loyalty discounts to existing investors. 6 The year ended 31 December 2017 was described as a watershed moment for LIVs in Australia, with circa USD 2.9bn raised across 14 listings. Several factors are attributed to this surge; a growth in self-directed investment flows (namely self-managed superannuation funds), increased demand for diverse investment strategies that are easy to access, and structural changes to distribution channels. Several innovations have also occurred in the Australian listed investment product space to increase their attractiveness to investors. Namely: 1 Offer costs being borne by the manager breaking from past practice, many LIV managers absorbed the offer costs enabling investors to avoid taking a hit in the value of their holdings on the first day of trading. 2 Alignment of interests many managers now take direct stakes in the products they distribute, several provide fee rebates if target investment returns are not met, and there is now a trend to reinvest fees into the managers holdings. 5 PwC ETFs: A roadmap to growth 6 https://www.morningstar.com.au/stocks/article/weighing-listed-investment-trusts/8823 PwC 3

4 3 Investor distributions some funds now provide explicit target yields and/or distributions for investors. 5 Investor discounts existing investors may be given bonus units in newlylaunched LIVs paid for by the manager. Distribution reinvestment several fund managers are providing distribution discounts paid by them directly in order to encourage fund growth. 6 Self-directed investment products authorising more investment products would allow investors to take a more active role in selecting investments which suit their needs. Such an increase in investor empowerment would potentially lead to a more engaged investor class and more sophisticated investors. 7 More digital distribution options digital distribution platforms are excellent channels to distribute products like LIVs and ETFs to individual investors, particularly those in the mass-retail segment. 7 Markets across APAC would benefit from the further adaptation of LIVs as they would deepen the investment product pool available and encourage local, regional, and global managers to domicile more investment products across the region. Another product type gaining prominence are Actively Managed Certificates ( AMCs ). These are structured products whose underlying strategy and components can be adjusted over the product life at the discretion of the investment manager. Product performance is tracked by calculating the value of the index the AMC is based off which can be tailored to investor needs. 8 The products are typically targeted at HNWIs and private banking clients and can reflect collective investment schemes, though they are designed for professional investors and can avoid being registered with some APAC regulators. 9 Indeed, some global wealth managers and private banks in APAC favour AMCs as they can be launched within two weeks and can launch with a lower minimum asset size compared to other products. 10 Major ETF players in APAC As stated earlier, within APAC, the landscape and outlook for the ETF markets across different jurisdictions is varied. Japan holds the largest amount of ETFs with approximately 61% of AUM, China accounts for another 16%, and Hong Kong contains nearly 8% of regional ETF AUM. Japan, APAC s largest ETF market with over USD 308bn in ETF AUM, should not find its position challenged anytime soon, though it is likely to find its dominance greatly diminished in the coming years as other regional centres grow at faster rates. 7 https://institutional.anz.com/insight-and-research/asx-listed-investment-vehicles-are- Changing-Fast 8 https://www.caplaw.ch/2015/the-rise-of-actively-managed-certificates/ 9 https://www.theasset.com/wealth-management/33021/why-actively-managed-certificatesmay-catch-on-in-asia?id=33021&subm=weath-management 10 https://asianprivatebanker.com/investments/portfolio/dpm/cs-launch-supertrends-mandateusing-amcs-streets-slow/ PwC 4

Japan is also home to the largest regional ETF players and may look to export their product knowledge across the region. While the domestic ETF AUM of Japanese managers does not increase at a great pace, their operations in other APAC markets may drive regional growth. China s rise is likely to benefit Hong Kong as an ETF centre with initiatives like the ETF connect, a cross-border scheme expected to launch in the second half of 2018. With such initiatives, Chinese investors would gain exposure to ETFs listed in Hong Kong and vice-versa, resulting in Hong Kong s proportion of ETF AUM across APAC to rise. Hong Kong also benefits from a permissive ETF regime that allows leveraged and inverse ETFs to trade in the territory. Other APAC players of note include South Korea, Australia, and Taiwan with USD 35bn, USD 20bn, and USD 17bn in ETF AUM respectively. Chart 3 - Map of APAC region with ETF AUM by country displayed and percentage of top five funds Total AUM USD 80.29bn USD 39.57bn USD 35.05bn China USD 308.25bn USD 0.18bn USD 0.47bn Hong Kong Taiwan South Korea Japan USD 16.52bn Thailand USD 0.48bn Vietnam Malaysia Philippines USD 0.029bn Singapore USD 20.20bn USD 2.28bn Indonesia USD 1.49bn USD 0.45bn Australia Source: Bloomberg, PwC New Zealand Top-5 ETF Fund AUM % Australia China Hong Kong Indonesia Japan 36.57% 48.18% 77.16% 73.42% 69.74% Malaysia New Zealand Philippines* Singapore South Korea 97.79% 45.71% 100% 68.39% 35.65% Taiwan Thailand Vietnam^ 47.62% 95.33% 100% *Philippines only has 1 ETF ^Vietnam only has 2 ETFs PwC 5

The future for ETFs While APAC ETFs may lack the overall AUM of their American or European peers, their outlook is bright. Increasing regional wealth at all levels, greater ease of investing through mobile and FinTech platforms, a stronger desire for diversification of investments, and continuing developments in promoting cross-border and fund passporting programmes are strong drivers to effect change and increase the attractiveness of ETFs among APAC individual investors. Across the region, regulators can help further the development of ETFs in their jurisdictions by several means, including: Promoting or being open to direct methods of product distribution through mobile and FinTech platforms; Allow a wide and diverse range of ETF products such as leveraged ETFs, inverse ETFs, and other listed products to operate in the market; Where mandatory occupational defined contribution individual pension schemes exist, allow suitable ETFs to be an investment choice for discretionary or default investments as not only do they tend to offer lower fees, but diversification is built-in. Both Singapore s Central Provident Fund ( CPF ) and Hong Kong s Mandatory Provident Fund ( MPF ), the two territories mandatory occupational defined contribution individual pension schemes, are taking steps to lower fees to contributors in order to help safeguard their retirement savings. Ensuring that suitable ETFs are eligible for contributors would provide CPF and MPF contributors with access to low-cost, diversified investment products to aid in their retirement savings. In coming years, we see several key developments as being crucial to the growth of ETF AUM across the APAC region, namely: The ongoing shift from active to passive the generally lower fees and diversification of ETFs make them attractive to all individual investors and, as APAC s wealth continues to increase, this should help ETF AUM rise as investors become increasingly assertive in their choices. Increased distribution access for individual investors as their wealthy clients increasingly demand products with lower fees and greater diversification, even private banks are starting to offer ETFs in their product suites. At the other end of the wealth spectrum, the increasing number of mobile platforms and FinTech investment channels are making investment easier for the massretail segment. China s MSCI inclusion and continued opening-up the inclusion of MSCI A-Shares is likely to lead to increased interest in accessing Chinese securities and ETFs can provide a way for investors of all stripes to access the growing market. When the ETF Connect is launched, global and regional ETF players will have an added incentive to have Hong Kong-listed ETFs in order to sell them to Chinese investors who are increasingly clamouring for overseas investment options. Continued maturing of defined contribution schemes there is a global shift away from defined benefit pension plans to defined contribution ones and the APAC region is no exception with CPF, MPF, Australian Superannuation, and New Zealand s KiwiSaver schemes all being examples. As these and other regional retirement schemes mature, they increasingly look for ways to lower fees to members and increase diversification to protect less savvy scheme participants. As ETFs fulfil both requirements, we expect to see increasing numbers of such retirement schemes adopt them which in turn should boost their AUM across the APAC region. Growing FinTech and online distribution platforms FinTech, mobile, and other online platforms are breaking down barriers to investing and providing millions of new and existing investors with access to products, generally at lower fees than traditional distribution channels. ETFs and LIVs are good matches for this new-age distribution model and, as regulators across the APAC region grow more permissive in terms of the adaptation of new distribution channels along with ETF and LIV products, can help further investor empowerment in discretionary and retirement investment schemes. Globally, ETFs have seen huge AUM growth since their inception in 1993. Within APAC, their AUM lags against other areas like the USA and Europe but has high potential for growth. To help facilitate the expected surge in regional ETF AUM, regulators across APAC should take steps to allow as much access for investors to the products as possible and engage in cross-border programmes which would allow for easier listing requirements of ETFs across the various regulatory jurisdictions. Adapting such policies would be beneficial to investors and the region alike and encourage greater development of the AWM industry across APAC. PwC 6

Appendix Defined as a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. 11 ETFs differ from mutual funds as ETFs trade like equities on an exchange. Accordingly, their price changes throughout the day and they typically have higher liquidity and lower fees than mutual funds. These make them attractive investment options for individual investors, especially those in the mass-retail segment. ETFs are generally constructed in the following manner: Exchange-Traded Fund What is it? An ETF, is a fund designed for individual investors that is listed on a stock exchange. ETFs can own underlying assets like: Stocks Bonds Gold Oil futures Foreign currencies Open-ended An ETF s outstanding shares can change daily. Pricing An ETF s NAV is not calculated each day. Ownership Transfer ETFs can be bought and sold easily through public exchanges. Types of ETF History of ETF Index Actively managed Bond Commodity Industry Style Inverse Foreign market Exhange-traded notes 1993 Standard & Poor s depository receipt s creation (beginning of ETF) 1996 International ETFs debut 1999 ETFs enter the Asian market 2001 2002 ETFs introduced in Europe Bond ETFs debut 2017 ETF AUM reaches USD 1tr 2010 Over 5,000 ETFs listed on exchanges with total AUM in excess of USD 4.7tr Pros Cons Low/no brokerage commissions Tax benefits Liquidity Built-in diversification and wide range of products to suit different investment goals and risk tolerances Some ETFs may have wide bid/ask spreads Tracking errors can occur Settlement delays 11 www.investopedia.com PwC 7

www.pwc.com/sg Look out for our next monthly edition of AWM Market Research digest to be released end-july 2018. Subscribe to our future research digests at our website here https://bit.ly/2jiidms Contact Armin Choksey Partner, Asian Investment Fund Centre & Market Research Centre Leader PwC Singapore + 65 6236 4648 armin.p.choksey@sg.pwc.com Conal McMahon Senior Manager, Market Research Centre PwC Singapore +65 9678 0331 conal.j.mcmahon@sg.pwc.com 2018 PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers and PwC refer to the network of member firms of PricewaterhouseCoopers International Limited (PwCIL), or, as the context requires, individual member firms of the PwC network. Each member firm is a separate legal entity and does not act as an agent of PwCIL or any other member firm.