Even without the evidence supporting the robustness of index funds thus far, truly convicted investors should stick to their guns, crisis or not, said Vanguard’s Hong Kong head of distribution Linda Luk to finews.asia.
On size alone, Luk underlines that index funds represent a mere 15 percent of U.S. equity market capitalization and less than 5 percent of trading volume – levels that she does not believe can move markets or produce inefficiencies.
Another commonly cited worry is the risk of a potential liquidity crisis for ETFs especially in the event that even the underlying securities face selling difficulties. Interestingly, the market of ETF investors may be setting a precedent that not only resolves this issue but enhances the product’s liquidity beyond its underlying securities.
Recent Turbulences
In the face of recent turbulence that caused a decrease in bond liquidity, 80 percent of fixed income ETF trading took place in the secondary market without even the need to unwind underliers.
«There does not seem to be convincing evidence that the growth of index funds has had an impact on market volatility or dispersion of stock returns,» Luk reiterates. «We don’t believe that the passive market is a ‹ticking time bomb›.»
DPM Advocates
One major benefactor of ETF adoption in Asia has been private banks, driven by demand for discretionary portfolio management (DPM) coupled with greater investor scrutiny of performance and fees. According to Luk, the industry has undergone steady growth and ETFs now represent 10-20 percent of DPM assets in the region.
From replacing active managers for low-cost core allocations to expressing tactical views such as sector bets or factor rotations, ETFs are increasingly becoming a staple on the shelf of discretionary managers.
Pay-to-Play Model
In addition to investor demand, banks have also encouraged adoption through various means such as the combination of ETF and mutual fund coverage under a single team – an effective way to gauge the value of active managers – or greater promotion via advisory solutions.
«Although the traditional advisory business is still dominated by active mutual funds due to the ‹pay-to-play› model and the belief of active management in pursuit of alpha, we see an increasing significance of ETF distribution in private banks,» Luk said, referring to the longstanding trailer fee conundrum in the region.
Merely Homework
As with any other financial trend, any perceived feeling of excessive crowding will lead pundits to call «bubble». But within the world of ETFs, Luk believes even the act of crowding needs to be better defined as index investing is «not a monolithic investment strategy» with exposure in increasingly diverse styles and markets.
Regardless, Luk believes such debate is merely homework that convicted investors should have completed long ago.
Tune Out the Noise
«Whatever the case, a recession or crisis should not change an investor’s strategy,» Luk said. «We urge investors to stay the course. Tune out the noise, focus on your long-term goals, and let the benefits of diversification and low costs play out.»
