By Chee Jo-Ey

BURSA Malaysia will soon witness the launch of three pairs of exchange-traded funds (ETFs) with the first one expected to be floated on the local bourse by the end of the month.

This comes on the back of a low appetite for passive investing. Checks on Bursa Malaysia show only 11 ETFs so far since the launch of the maiden ABF Malaysia Bond Index Fund, which was listed on July 18, 2005. Question is, how will this new batch of ETFs excite the local bourse?

Kenanga Investors Bhd executive director and CEO Ismitz Matthew De Alwis tells FocusM that these new ETFs are powerful investment tools that will be able “to give alpha (the excess return over a benchmark) to traders and investors alike if used correctly”.

The ETFs comprise a pair of leveraged and inverse (L&I) ETFs tracking the local FBM KLCI and two pairs of L&I ETFs tracking foreign indices.

Leveraged ETFs are financed by debt to amplify returns while inverse ETFs are designed to profit from a decline in an underlying index.

But Bursa Malaysia notes that these instruments are not for everyone – there are requirements to fulfil. Investors have to meet one of these four criteria:

  • Investors who fall under the category of sophisticated investors (typically rich investors).
  • Investors who have margin accounts with their brokers.
  • Investors who have made at least five transactions in exchange traded derivatives or structured warrants in the preceding 12 months.
  • Investors who have utilised a performance simulator which simulates trading in L&I ETFs and have undergone the video tutorials on L&I ETFs on Bursa Marketplace.

According to De Alwis, leveraged ETFs allow investors to “amplify the returns” on their investments while inverse ETFs provide a hedge by giving investors “the opposite returns” of a market. “Inverse ETF will profit when the market is down,” he adds.

Pushing for ETF growth

Malaysia has legislation in place to encourage the growth of ETFs. For example, the Securities Commission has revised ETF guidelines to support the development of new ETF products such as futures-based ETFs and commodities ETFs, to name a few.

Ismitz Matthew De Alwis

“In a bid to further stimulate the industry, regulators have implemented changes such as reducing the capital requirement for an ETF issuer from RM10 mil to RM2 mil, and exempting stamp duty over ETF trades,” says De Alwis.

The changes to the local ETF space mirrors the rise of popularity for passive investing in other countries. The global ETF market has recently achieved US$5.8 tril (RM24.1 tril) in assets under management as at Nov 13 this year.

ETFs’ attractiveness has always been their versatility to suit the needs of retail and sophisticated investors. They are also typically cheaper compared to many mutual funds.

ETFs are popular in the US and Europe because actively managed funds have been having a hard time beating the market in recent years, prompting investors to think that it might be better to stick to lower-cost ETFs that can maximise their returns.

In fact, this is not only a Western phenomenon. For example, L&I ETFs have gained traction for years in Asian economic powerhouses such as Japan, Taiwan and South Korea.

Global popularity

iFAST Capital Sdn Bhd research analyst Jerry Lee Chee Yeong notes that it is not too late for Malaysia to jump on the ETF bandwagon. The new ETFs, he opines, would foster greater innovation.

“We believe the move of introducing L&I ETFs in Malaysia is mainly for the purpose of bringing in more innovative investment products as well as to expand the options of investment products that are available for local investors. Globally, we see an increasing demand for passive investing mainly due to the lower investment cost,” he says.

But Lee cautions that, as with any other investment instrument, Malaysians have to do a cost-benefit analysis.

“Instead of just mulling over the costs, investors should take a look at the performance of some actively managed funds and compare them against the ETFs that are investing in similar country or regional equity market.”

Lee also adds that ETFs that focus on developed market equities tend to perform relatively well due to greater market efficiency. “But in markets like Malaysia, actively managed funds have proven to be better investment tools.”

Qualified investor

But will artificial barriers to purchase these new ETFs bode well for the local bourse? “The criteria are meant to protect local investors,” says Lee. He cautions investors that leveraged ETFs are akin to a double-edged sword. “While it could amplify your potential returns, it can also magnify your losses.”

As for inverse ETFs, Lee observes the need for greater investor awareness.

“An inverse ETF helps investors to make profit from a declining market, meaning investors are shorting the equity market. Although investors are now allowed to short sell certain stocks in Bursa Malaysia, the short selling activity has not been a popular or well-known strategy to local investors. Hence, the regulator owes the responsibility to make sure that local investors have proper understanding and knowledge before investing in such investment products,” he says.

But education has to be prioritised. Lee notes that investors’ understanding and knowledge on such L&I ETFs may not be very strong, “hence providers might have to put in more effort to improve their understanding which would subsequently lead to increasing acceptance of such products”.

Kenanga’s De Alwis concurs that L&I ETFs are only suitable for specific investors. “They are mostly suitable for qualified investors who are comfortable with taking on the risks inherent to L&I ETFs. They are for investors who are willing to accept the risk of substantial losses up to the principal investment amount, possibly within a very short time frame. Investors should conduct their own research on L&I ETFs before deciding if such ETFs meet their investment objective, especially when there is the leveraged element,” he says.

But these remain “a great option” despite the complexity and risk, adds De Alwis. “Besides offering diversification and exposure to equities, currencies and other assets at different levels like sector or country, it has low expense ratios, and is tax efficient and flexible (ie buy and sell during trading hours).”

Indeed, the three pairs of L&I ETFs look to provide a wider range of options for investors. While they are powerful instruments, there are risks involved, hence a stricter criteria. The question is, will there be a higher take-up since participation is determined by the regulator and not the market?

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