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ETF issuers strike gold in Saudi Arabia

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This week our columnist Allan Lane of Algo-Chain writes on the difficulties of identifying the next best thing in ETFs…

Over the years I have often been asked what constitutes the next big idea in ETFs and my answer has never really changed. Coming up with a good idea is really not that hard but coming up with an ETF that will prove popular, now that’s a different matter.

It has been barely a year since Invesco launched its Invesco USD MSCI Saudi Arabia UCITS ETF, before both iShares and HSBC followed suit.  What is it about London buses that they only arrive in threes?  In this instance these ETFs have a combined total assets under management that will soon cross the USD2.5 billion mark.  Who said passive investing was boring?

As a micro case study, this story perfectly reflects what drives the industry and what the challenges are any issuer faces as they look to beat down their competition. Let’s deal with the first part of the thesis – what’s behind the growth of these new ETFs?  In a word, MSCI’s reclassification of Saudi Arabia as an Emerging Market country, previously categorised as a frontier market, making it eligible for inclusion in the MSCI Emerging Market Index.  Overnight many fund managers faced the challenge of how they could get exposure to Saudi Arabia’s equity market.

Many commentators tend to over complicate the business case for launching an ETF, yet often it is a single reason that lights the gunpowder.  With this example it was purely about access to a market that had previously not been open to all categories of investor.  Who can ever forget the case when WisdomTree’s currency hedged Japan ETF saw a whopping USD15 billion in inflows for the simple reason no other firm offered that hedged exposure when US investors so desperately wanted to hedge out their Yen currency risk?

It is better to share a slice of a large pie than to own 100 per cent of a pie that no one wants as seems to be the case in the new issues space.  Invesco was first to market with their swap-based ETF, and before you ask that is an excellent way to ensure very little tracking error when managing the fund.  Their fee came in at 70bps per year, which includes a fee of 20bps for the underlying swap.  iShares have never been a fan of synthetic ETFs so no surprise that their ETF physically replicates the index and decided that a fee of 60bps would undercut their competition.  Little did they know that HSBC, who are well known for strutting their stuff in the Middle East, would enter the market with an even lower fee of 50bps.

How should one choose amongst these three products?  Is low tracking error of critical importance, or indeed is cost the factor that drives decisions or how much AUM is in an ETF?  Not to mention the liquidity of the ETF and the whole issue of expertise in that specialist area of the equity markets or the power of a global brand. 

Net net, it does feel that issuers face very difficult strategic questions when launching a product, but likewise for investors. With so much choice and so little time, it does seem that given too much choice can get in the way.

 

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