## Wednesday, February 17, 2010

### Implications of ETF on the Hang Seng index that's traded in India

I have a column in Financial Express today on this subject.

1. This is the first ETF but there are also 10-15 non-India mutual funds which have been around for some time and which provide create global diversification opportunities. Additionally, the availability of different asset classes in MF form is useful: commodities/real estate/agri.

Speciality MFs (ValueResearchOnline)

2. Oops, on taking a closer look all the MFs are equity funds only as opposed to investing in commodities/real estate/agri directly.

Also, some are wrappers on other global funds which is not so good from an expense ratio perspective.

3. This is good development and we do not want to criticized till our NIFTY get list on CHINA STOCK EXCHANGE
Few takers for this so not much giving attention
but positive note for this step we can say INDIA now matching step with global exchanges

4. The Benchmark offering may not be too expensive.

An exact apples to apples comparison seems difficult as there seems to be very few Hang Seng ETFs, besides the Tracker fund in HK, which in some ways (it's history) is actually a different beast (expense ratio seems to be 0.1%).

As per the offer document for the FTSE/Xinhua China A50 Index management fee is 0.99% p.a. of Net Asset Value calculated daily and estimated total expense ratio of 1.39% p.a.

This is the largest China ETF listed in HK and is one of the most actively traded securities on the HK exchange.

http://hk.ishares.com/content/stream.jsp?url=/content/hk/en/repository/material/prospectus/2823_prospectus.pdf

iShares MSCI Hong Kong listed on NYSE has an expense ratio of 0.55bps.

For ETFs listed on the HK exchange try the middle link.

http://www.hsi.com.hk/HSI-Net/HSI-Net

5. ETFs in US and Europe and cross listed ETFs have fees between of 80to 150 basis points.

Also most of these country ETF's are Swap (P Note type structures) based. Therefore they carry credit risk on the Swap provider. And also most of them provide price returns and do not include the dividend yield.

The TRACKER ETF was created post the Asian crisis to off load the securities bought by the HK authorities and is kind of subsidized.

Anyway our endeavour would be to bring down the fees as the fund size increases and provide fees similar to the Nifty BeES which is 50 bp.

For more information on the costs and other details on international ETF’s do have a look at www.indexuniverse.com and the following report

http://www.blackrockinternational.com/content/groups/internationalsite/documents/literature/etfl_industrypreview_yr_end_09.pdf

Benchmark

6. Anonymous/Benchmark, Thanks for linking in the Blackrock report.

However, it indicates that average equity ETF fees in the Europe and US are 37bps and 32 bps respectively. Average international equity etf fees are 50-60bps. So, I'm not sure why you indicate that it is higher?

For example:
EWH
has an expense ratio of 0.55% and aims to match price and yield performance (not just price).

Now this particular ETF does have a tracking error of 1.5% (annual) so if the expense ratio is traded for better tracking that would be fine. Does the Benchmark ETF use a method which would ensure lower tracking error?

Additionally, UCITS compliance requires most swap-based ETFs to limit the swap portion to 10% of fund value so the credit risk is limited.

ETFs in the US which track local indexes have much lower expense ratios (e.g.; SPY has an expense ratio of 0.2%, temporarily 0.1%) and atleast this one doesn't have any significant tracking errors. The NIFTY Bees expense ratio is high in comparison, wouldn't you agree?

7. Dear Anonymous,

I could not open the Blackrock report so cannot comment on it, but I happen to be an investor in ishare ETF's on the MSCI India and FTSE/Xinhua.

They happen to be the largest such funds and they charge nearly 139 bp and no yield performance with credit risk on the whole portfolio. so I do not know how you say that the fees on international funds are lower.

Besides your assertion that credit risk on some are only 10% is pretty incredulous, when I buy an equity risk, i do not want an added credit risk of even 1%. Do let me know the logic of taking even a small credit risk on an equity portfolio.

Another point I should mention here is that all the US based ETF's which invest directly into underlying stock lend such stock. The income from such lending does not accrue to the ETF investors but flows to the asset manager. Thus the fees are low. This was a big driver for Blackrock to acquire BGI. I am sure you are aware of this.

Do let me know which Nifty or Indian market index based funds are cheaper than Nifty Bees, Sundar, etc

8. Index Investor,

1) Do you mean the MSCI India ETF available in Singapore: (I98)? The US example (EWH) does claim to replicate price and yield performance and has lower ER.

2) "so I do not know how you say that the fees on international funds are lower". I should clarify that I was quoting the Blackrock report and meant: international equity funds available in the US/Europe. And the example I looked at was the US ishares EWH fund.

3) "Do let me know the logic of taking even a small credit risk on an equity portfolio." From what little I know, the argument is that swaps/synthetic instruments can track the index more closely and at lower cost (as compared to actually holding a representative/replicative basket of stocks - in particular doing this for international funds may be costly). Anyway, if an ETF provider claims that they have higher costs because of no synthetics, credit risk, etc maybe its worth it - I'm ambivalent on this.

4) "I am sure you are aware of this." I was not aware of this (and certainly don't claim any particularly interesting level of expertise in how ETFs are setup). The US ishares funds indicate that they might lend out their holdings and so does the SGP fund (I98). If it reduces the ER I'm not convinced its such a bad thing. By the way, the SPY ETF that has a low ER of 20bps does not engage in lending.

5) "Do let me know which Nifty or Indian market index based funds are cheaper than Nifty Bees, Sundar, etc" That was not my point. I was comparing local index ETFs in India with local index ETFs in the US (like the SPY). The differences may well be justified, I'd just like to what they are. So far I haven't found any reasons. Afaik, SPY holds the stocks directly (does not have synthetics) and does not engage in lending out its holdings.

9. Dear Anonymous,

1 and 2 -as I mentioned earlier I pay the fees on International ETF which are the largest such funds. I cannot open the Blackrock report so cannot comment. But being a 'only ETF' investor my analysis shows most non local ETF are around 1%. I am sure there are a few which would be cheaper (as mentioned by you) or more expensive, I am talking here the fees charged generally.

3 - when I buy an Equity ETF I want Equity risk and no credit risk. Period. 2008 gives a good reason.

4 - sure it is not a bad thing (except it adds to the credit risk of an ETF, albeit limited due to collateral) but the income from such lending should accrue to the investor (collective owner of these assets) and not to the asset manager

5 - if you are comparing US markets, please also consider the size. By the way SPYDRS do have a capacity to lend (whether they do it presently, I do not know). I have been looking for ETF which have absolutely no credit risk ( lending does generate some) and in US difficult to find one.

10. 1 and 2 - I didn't get the answer to my 1st question. If you are indeed investing in the I98 ETF then you are overriding your concerns because it does engage in lending out its holdings?

Additionally, how can you claim generality by presenting your own example and rejecting stats quoted from a report just because you cannot open the report?

3) None of the ETFs had credit problems during the crisis so 2008 would in fact serve as a successful stress test? ETNs are clearly problematic from a credit risk point of view. However, this is a matter of personal preference and risk profile so your stand is reasonable and prudent in its own right.

4)Fair enough. A small fraction of it does but not enough.

5) SPY is set up as a unit investment trust which does not allow it to engage in securities lending or derivatives. One would be hard-pressed to find an ETF in the world that is less risky than the SPY. By the way, mutual funds engage in securities lending as well so its not an issue unique to ETFs.

11. Dear Anonymous,

1 and 2 – I have nothing new to say

3 – It is a matter of principle and not personal preference. One should not be even thinking of stress situations. Credit risk should not be part of the debate, it should be irrelevant. But you have made a good suggestion in terms of ETN. ETF’s which carry credit risk could be defined as ETN or ETP (product) rather than ETF

4 – Assets are owned by the ETF investor, any income on it should flow back to the investor

5 – As far as I know SPYDR cannot do derivatives, but have ability to lend.

12. JB, Ctrl C + Ctrl V, Amit, Anonymous, Index Investor,

Thanks for debating the issues relating to ETF’s. It is great to have a discussion on the issues of ETF’s especially on ETF cost and structure. Hope ETF’s are becoming a mainstream investment product investors in India and for everyone to discuss, debate. Please do carry the discussion, debate forward.

In terms of the Expense Ratio, we have detailed below the fees charged on some of the Indian ETF’s. Nifty BeES and the other funds on Nifty in India charge .50%. And therefore do happen to be the lowest cost ETF on a broad Indian index. The cost as we mentioned in the previous comment about Hang Seng BeES will come down as the size of the ETF space grows. In fact a good indicator is the fees bid for Pension fund management. Based on expected size the fees charged were really low.

Lyxor ETF S&P CNX NIFTY 0.85

Lyxor ETF MSCI India 0.85

PowerShares India 0.78

WisdomTreeIndiaEarnings 0.88

db x-trackers NIFTY ETF 0.85

iShares India Nifty 50 0.89

In terms of the structure of ETF’s, we understand that IOSCO and the individual regulators are seized of the issues especially in terms of Counterparty risk.

As for us, we are believers in complete replication.

Benchmark

13. Index Investor,

I couldn't find evidence that the SPY allows lending out its securities but the select sector SPDRs (XLY/XLE, etc) which have a different structure from the SPY do allow lending of upto 33% of their holdings so you may be right with the sector SPDRs.

I haven't found any non-US ETFs (other than perhaps the Shariah ones) that don't allow securities lending. Do you know of any?

And, the Benchmark NiftyBees SID indicates that it can engage in derivatives and/or securities lending for upto 50% of the portfolio.

Benchmark,

Does the fund actually engage in lending (or is it just allowed at this point) and do the gains filter through to the investor?

It is unfair to compare expense ratios of the other ETFs with NIFTY Bees because the others are not domestic and have to invest via the FII route which would have its overheads. A better comparison is domestic ETFs in other countries. 50bps is not too bad but I hope with size the NIFTY Bees (and other domestic ETFs) can get cheaper.

14. Does the fund actually engage in lending (or is it just allowed at this point) and do the gains filter through to the investor?

....No we do not lend our securities at present and the gains from such lending, if and when it happens, would be added to the NAV and passed on to the investors in the funds.......

It is unfair to compare expense ratios of the other ETFs with NIFTY Bees because the others are not domestic and have to invest via the FII route which would have its overheads. A better comparison is domestic ETFs in other countries. 50bps is not too bad but I hope with size the NIFTY Bees (and other domestic ETFs) can get cheaper.

....in case of expense ratios we think it should be the other way around, quiet a few ETF'S are based on P note structures so the cost of Indian set up is minimal and they do have a size advantage.

But sure, the Expense ratio would be inversely proportional to the AUM and should come down once size increases…..

Benchmark

15. Dear Anonymous,

Agree. That is why I am not very happy about investing in the ETFs I mentioned above. Well, it is still better than investing in an actively managed fund, which no investor should do!!!

16. sorry.. i'm newbie here and i don't really understand about his discussion. is that mean all of non-US ETFs don't allow securities lending? please give me more information

17. On the cost topic, Fidelity US now allows commission-free trading of 25 selected ETFs:

Fidelity

18. I think Indian BSE and NSE should come to solve the household portfolios in India.

19. I think we should apply new regulation regarding Indian household.

20. this is great achieve ment ever done by the company it will benefit investor.

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