Global Industry 2017

HONG KONG ROUNDTABLE: The view from the east

Pan-Asian fund passporting, cash-rich corporates and an ageing population were among the topics discussed by our Asian panel. Chaired by Funds Global Asia editor George Mitton in Hong Kong.

Beonca Yip (managing director, head of advisor business Asia, Investec Ssset Management) 
Wayne Shum (head of sales, Value Partners)
Showbhik Kalra (head of intermediary and product Asia, Schroders)
Alexis Ng (head of distribution, Asia Pacific, Aberdeen Standard Investments)
Rakesh Vengayil (deputy chief executive, Asia Pacific, BNP Paribas Asset Management)

Funds Global – Is global regulation harmonised enough to facilitate product development in a way that one product can be duplicated in numerous jurisdictions, so lowering costs and gaining efficiencies for asset management businesses?

Wayne Shum, Value Partners – In Asia, it is far from fully harmonised. Apart from several separate regional fund passporting schemes – the mainland China-Hong Kong Mutual Recognition of Funds (MRF), the Asia Region Funds Passport (ARFP), the ASEAN collective investment schemes (CIS) – the region is still quite fragmented.

Even within these fund passporting schemes, the local regulatory requirements, market practices, investors’ appetite, etc., would all have significant implications on the kind of fund structures and the type of investment products to be allowed in the participating countries. So, duplicating investment products across different jurisdictions in the region would not be simple and straightforward.

Alexis Ng, Aberdeen Standard – There is more harmonisation in the alternatives investments funds space. Cayman-domiciled structures, for example, are widely accepted, not just in Asia but in Europe and the US. I see more fragmentation in the regulations governing public market funds. Although Ucits is quite prevalent, there is still a need to set up feeder fund structures in many parts of Asia to take into account local considerations.

The direction of travel, especially when it comes to Asia-Pacific, is one of further fragmentation. Looking into where the regulators are standing and the direction that they are pursuing, it is definitely not one-size-fits-all.

Rakesh Vengayil, BNP Paribas AM – As a global asset manager, harmonisation of regulation to facilitate product development across geographies in which we operate is an important factor because there is a huge opportunity to leverage on the products we develop centrally to distribute in various jurisdictions. Currently, this proves to be challenging given that there is no such global harmonisation, but I believe this will invariably be a top priority soon across key global markets. The US remains closed, for example.

Then there is European regulation (Ucits) on which significant economies of scale can be obtained across Europe, several Asian countries as well as some Latin American institutional investors.

Although Asia is currently fragmented, there is a growing trend in harmonising the regulations across some countries as multiple fund passporting regimes are being developed.

Showbhik Kalra, Schroders – The end investor in this part of the world, for the most part, does not necessarily care where their fund is domiciled. They are quite accepting of Ucits. Additionally, if you are designing a product to have appeal across markets, Ucits gives you access to multiple markets and allows you to build scale, as none of the Asian passporting schemes are really relevant yet. At least for now, the Asian passport is effectively Ucits.

Beonca Yip, Investec – From a distribution perspective, many of our clients are global companies, and what they really want is to access, as efficiently as possible, our whole fund range. What we have seen is that regulation actually restricts us from doing that.

You can’t talk about efficiency without taking into account product development in the fund management industry. As a global firm, we can decide where our managers should be based. Should the team be based in London, or should the funds be domiciled in Hong Kong as well as the fund managers?

From our clients’ perspective, it can improve efficiency if we can be more globalised and work in line with their platform requirements. However, the changing and increasingly complex regulatory environment is requiring asset managers to invest.

Feeder funds may be an option, but we have to consider different factors before we can decide whether it is suitable and worth doing in each of the local countries.

Funds Global – What is the prevailing product type in your region at present and what are the underlying drivers for that demand?

Shum – In general, Hong Kong investors are looking for yield and favouring investments that generate regular income. This has been an important consideration when launching new investment products in recent years. According to some industry surveys, equity funds have been experiencing net outflows, while multi-asset and fixed income funds have been seeing net inflows for the last couple of years. This reflects the current conservative investor appetite and risk-off market sentiment.

Ng – The client discussion is increasingly about the outcomes the client would like to achieve. For example, can you produce something to deliver income, or growth with low volatility, or an absolute-return target? More and more, clients are looking for a solution rather than a product.

This is probably driven by how investment markets are performing. It’s increasingly difficult to call overweights and underweights across asset classes, countries and sectors. The investment cycle is also getting much shorter. As such, many of our clients are saying to us, “I don’t want to make any asset allocation decision. Can you do this for me instead and deliver the outcomes I am looking for?”

We also see growing interests in alternatives. Investors may want to buy illiquid assets but want to overlay the exposure in a vehicle that provides liquidity. People want that illiquidity premium but without sacrificing liquidity.

Vengayil – There is generally increased demand for fixed income as an asset class. I believe this points towards risk aversion by investors, which has been prevalent for a number of years. However, this year has seen the return of risk appetite, although the flows into equity, for example, at the moment remain modest.

We are also seeing some demand for environmental, social and governance (ESG) products on the institutional side. Interestingly, in some markets there is a push from governments to make this relevant, so that works in our favour as BNP Paribas Asset Management champions and is a strong advocate for initiatives in this space.

In alternatives, there is an increasing demand for infrastructure debt in Asia, and, surprisingly, we are seeing those demands coming in the local markets, such as Indonesia. Finally, if you look at markets like India and China, there is a demand for alternative investment funds.

Kalra – In the last few years, in a number of markets, regulators have required intermediaries to risk-rate their clients. In some instances, intermediaries don’t necessarily have a portfolio-level relationship with their client, it’s a product-led relationship, which means a low-risk conservative client is sold low-risk products. An equity product is generally classified as a high risk product, and unless you have a relationship with the client at a portfolio level, they are not likely to be sold equities.

There are a lot of aggressive investors in this part of the world too. A number of us have been surprised to see consistent outflows from equities, even though we have been in a very positive market environment for equities. Aggressive investors in the region have been leveraging credit products. It’s a trade that has worked well for them so far.

Yip – The ageing population in China and North Asia can explain the demand for income-driven or solution-driven products. It is an opportunity for asset managers, as our clients rely on us to manage portfolios and grow assets, which is different from ten years ago where investors were usually attracted by new and trendy products.

The question for us is where to find income. Is it from fixed income, or other sorts of substitute income such as infrastructure and reinsurance?

Funds Global – The quest for yield is still a major force in product design and demand. What innovations has the industry seen?

Shum – The market is becoming saturated with similar and hard-to-distinguish yield investment products so the industry needs to be more innovative in coming up with new investment themes. For example, leveraging our China and emerging markets expertise, One Belt One Road ideas are something we are looking at.

Institutional investors, who have a much broader investment appetite, could invest in non-traditional assets, such as infrastructure loans, private debts, etc, for alternative yields. However, these alternative strategies would have an illiquidity trade-off and might be suitable for only institutions with a long investment horizon or long-term liability.

Ng – The chase for yields started to intensify as interest rates became lower and stayed low for longer. Against this backdrop, investors started to focus more and more on income-replacement strategies, hence the increasing demand for alternatives such as real estate, private equity and infrastructure. With retail investors, the focus on income has also led to more complex funds and fund features. For example, some funds write options for premiums. That is great when the markets keep going up but what about when the reverse happens? Other funds have started to allocate to illiquid strategies. All these extension strategies are fine in itself but has investor education kept pace?

Vengayil – The hunt for yield has pushed investors down the credit curve, given the interest rate outlook. For the distribution business in particular, income is still the focus amid the low yield/return environment. Echoing the above, other than traditional stocks and bonds, asset classes such as mortgage securities and loans are getting their day in the sun.

Monthly distribution share classes are also a key feature nowadays in the Asian retail market, which could potentially pay dividend, or income, to investors on a more regular basis than the usual distributing share class.

We are also seeing the introduction of currency-hedged share classes to capture the yield pick-up from interest rate differential across currencies. The utilisation of derivatives to enhance income such as adding a covered-call strategy or providing downside protection is also becoming a more popular investment strategy among investors.

Kalra – I believe that the marginal new dollar entering the industry is leaving deposits and looking for replacement. Deposit rates give you very little. I believe this trend is a big driver in influencing demand and innovation.

A lot of income-bearing asset classes look overvalued. Asset managers are increasingly designing solutions that have the flexibility to navigate across markets and be more dynamic.

Yip – In Europe, I know that there are a lot of innovative solutions. Investors, in general, are interested in constructing portfolios or funds of funds. They usually focus less on the net asset value. In Asia, revenue is a main concern of distributors which is generated by the sales of front-line relationship managers who are usually commission-based. It can be worrying because what we do is to improve the financial wealth of investors.

Vengayil – There is one part of Asia where we have seen a different trend, which is India. There, we have seen a lot of money flowing into equities and distributors have been successful in propagating a systematic investment plan where they are saying, “Don’t time the market, spend time in the market – equities will work it out for you.” It helps that the average age of the Indian population is around 30-35, so the risk appetite is different.

Funds Global – The ‘vacuum’ of bank lending in recent years has prompted the development of non-bank lending vehicles. How has the asset management industry in your region responded, if it has had to?

Vengayil – In Europe, we have seen the evolution of direct lending platforms and BNP Paribas AM moved into this space by launching funds which invest in direct loans. But in Asia there is no real evidence of this happening.

Ng – It’s not so predominant across Asia. The trend in Europe started because of regulations on banks’ regulated capital. As a result of the banks shrinking their balance sheets in Europe, a marketplace started to develop for other market participants to come in, in the form of fund managers and private credit. Asian investors are interested in other areas, such as commercial real estate lending and infrastructure debt.

Yip – Also, a lot of our corporates are cash-rich, so don’t have that lending requirement. Because of the stringent regulations we have in this part of the world, I don’t foresee regulations being relaxed to allow this sort of investment – to the public market at least.

Kalra – The one exception in the region has been China, but it’s largely been a local-to-local business, where we have significant growth through wealth management products. You could think of this as similar to an asset-backed security market, but with potentially large asset liability mismatches. Recently, the regulator in China has stepped in to slow the market down because there are risks involved with the implicit guarantees which have fuelled the growth of the sector.

In the region, I am surprised we don’t have a more vibrant mortgage-backed and asset-backed (for instance, credit cards, student loans and auto loans) security market. Before non-bank lending, we need some of these more basic assets to start emerging.

Shum – Unlike other parts of the world, direct lending has not been a trend in Asia. I haven’t noticed any increasing risk of a bank lending crunch and institutions don’t seem to have a problem of borrowing money from banks in the region.

Funds Global – How fierce is the battle between active and passive in your region? How are active managers responding to the criticism they often receive for benchmark hugging?

Shum – Active versus passive is a constant debate, and there is no right or wrong answer. It all depends on the investor’s own investment belief, risk appetite, portfolio size and composition. Obviously, implementation effectiveness and market accessibility would also have an impact. We certainly believe there is value in active management and have been able to deliver active returns. Basically, a pure passive strategy or an index-tracking ETF would be forced to buy high and sell low, so when there is a major market correction, investors of such products would most likely be hit hardest.

Ng – Since the 2008/09 global financial crisis, central banks globally have lowered interest rates and flooded the market with liquidity, which means traditional measures of fundamental value have gone haywire. This has not helped active managers because a sound assessment of fundamental value is core to how an active manager generates alpha. Investors are increasingly also realising that active managers are active because of their engagement with the companies they invest in to monitor the alignment of interest between company management and our clients’ interests as shareholders.

There is a place in an investor’s portfolio for a variety of strategies, because the value propositions are different. There will be an increasing focus on risk budgeting and the value that investors expect for the fees they are paying their managers.

Vengayil – If you look at the distribution landscape in Asia, it’s predominantly driven by banks, and the biggest part of their revenue is generated from management fees. Asian investors have not provided the kind of bottom-up demand for passive funds that we have seen in the US.

Maybe you will start seeing fee differentials now. We have already seen some of the big fund houses moving away from conventional pricing to fixed and performance-based pricing. Those trends are emerging.

Kalra – With the exception of Australia, which has rules in place similar to the UK’s retail distribution review, basic industry incentives are still favourable for active managers because of retrocessions and upfront commissions. Unless we see regulatory change or the emergence of digital channels that disrupt existing business models, I do not believe there will be much client focus on the absolute level of fees. That being said, we are seeing regulators focusing on fees, and hence more passive solutions, in certain channels, such as the defined contribution retirement market.

Yip – Markets move in cycles. We have seen the rise of passive funds since the global financial crisis as it was challenging for managers to deliver alpha in that period. But we believe the time for active managers is coming back. Investors can now differentiate between the managers by fund performance more easily.

Active managers may generally be perceived to have a bad press and are criticised for benchmark hugging. That’s why we emphasise ‘active share’ of funds. We can do more education in this area as there are active stock-picking managers running portfolios with a high active share which do deliver excellent outperformance.

Funds Global – Would you agree with Mike O’Brien, the Europe, Middle East and Africa head of JP Morgan Asset Management, that smart beta will form a part of all portfolio analysis or design in ten years’ time?

Shum – It still requires a lot of education in Asia. Maybe in Europe, investors are more accepting of these types of strategies. While I have seen some larger Asian institutions start to invest in smart-beta, factor-based quantitative strategies, a regional trend is yet to develop.

Ng – We believe active, passive and smart beta all have a role to play in a client’s portfolios. Smart beta can bring an enhanced, holistic view of risk and drivers of returns. For example, if you are an active manager, you need to pay attention to momentum trends that could create some form of unintended bias in your portfolio construction. To have that sort of awareness means being more informed about the decisions you are taking with your portfolios.

Vengayil – We cannot rule out the possibility of smart beta forming a part of portfolio analysis, but it is not likely to be applied universally across all products. For the retail side, particularly in Asia, it might take a while for end investors to fully grasp the rudiments of the quantitative concept. Secondly, for certain markets with regulatory controls or intervention, we could end up with a situation where ‘factors’ may not reflect the actual economy behaviour, potentially resulting in smart beta not delivering the expected result.

Kalra – With an increasing amount of data, more computational power and sophisticated quantitative tools available to our fund managers, we are already analysing how we manage our portfolios in more nuanced ways.

Yip – The statement is very bold on the surface, but actually it is something a lot of our managers are already doing.

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