21 October 2016
PIMCO has snapped up more than half of the market share of all active ETF funds in the United States with its two products. Photo: Reuters
PIMCO has snapped up more than half of the market share of all active ETF funds in the United States with its two products. Photo: Reuters

Will ETMF help promote internet finance?

It’s quite possible that internet finance will break the long-time dependence on traditional distribution channels in the fund industry despite some difficulties down the road. And e-distribution will become the main channel for investors to buy fund products.

The popularity of the internet and smartphones has already changed our habits permanently. Growing demand for wealth management services from the new generation will continue to drive innovation in the sector.

The combination of internet and fund distribution has been around for quite a long while. Many banks, brokerages and fund companies all offered online distribution. However, these websites only help in the distribution and are not engaged in real “e-distribution”.

However, not too many people buy funds online — even in the United States where the fund industry is very developed. An ICI survey in 2013 shows that 92 percent of families who invest in mutual funds use the internet, but only 19 percent of them opt for online purchase of fund products.

Meanwhile, exchange-traded funds (ETF) have grown rapidly along with internet fund distribution platforms. ETF products are the top choices for online distribution. The key is whether investors can easily buy these ETF products without any professional guidance.

The most successful ETF product is definitely that which tracks an index. It was first launched in the New York Stock Exchange in 1993. Since then the ETF industry has grown into a US$2.5 trillion market that offers over 5,000 products.

About 99 percent of the ETF products in the US are tracking indices. These index ETF products are very easy for investors to understand.

The success of these index ETFs has prompted a number of active money managers to launch some ETF funds. However, unlike index funds, active money managers have to woo investors without any professional advice.

They usually need to overcome two main barriers. First, they need to win ordinary investors instead of professional investors. Active money managers usually have various investment strategies to suit different risk appetites.

Therefore, it’s not practical to compare two different funds just on the basis of investment return rankings.

Currently, two products launched by PIMCO are probably the most successful, with a gross size of over US$5 billion. They’ve snapped up more than half of the market share of all active ETF funds in the US. They have managed to build their reputation on the back of nearly three decades of excellent track record.

Second, the transparency of holdings. Most active funds will keep their holdings secret in order to protect their performance, and therefore they lack the same degree of transparency of index funds. That has also become one of the key weaknesses for e-distribution of these actively managed funds.

Exchange Traded Managed Fund (ETMF), a hybrid of an ETF and a mutual fund, is the latest innovation in the ETF space. Eaton Vance received approval from the US Securities and Exchange Commission for the new creation in November 2014. Eaton Vance’s stock soared 23 percent on the day it got the approval, reflecting market expectation for the new product.

With the ETMF, investors don’t buy or sell shares from (or to) the fund itself. Instead, they deal with market makers on a stock exchange at NAV plus a spread. The new pricing model will allow mutual funds to offer some transparency with a market-based spread without disclosing their holdings.

It remains to be seen whether the new product will help lift the industry to a new level.

This article first appeared in the Hong Kong Economic Journal on April 8.

Translation by Julie Zhu

[Chinese version 中文版]

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President of Dymon Asia; Vice Chairman of Chinese Financial Association of Hong Kong

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