While occasionally there are concerns that the ETF sector cannot grow much more or faces headwinds, a new report sees further upside, especially in China.

China accounts for a relatively small chunk (2.1 per cent) of the world’s $5.1 trillion exchange traded funds sector, but is poised for strong growth, and the global sector as a whole has considerable headroom, Brown Brothers Harriman says in a new report.

And while there are sometimes concerns whether such index-tracking funds can continue rapid growth if financial markets hit headwinds, the upside potential remains large, the US firm told this publication recently. There’s a lot at stake for BBH because it works with more than 40 ETF issuers globally.

ETFs, which typically charge less than conventional mutual funds and actively-managed portfolios, have boomed. They mimic returns from tracking market indices of stocks, bonds, real estate and other asset classes. This model appeals when markets rise, as has been (mostly) the case over the past decade in stock markets. Weightier regulatory burdens on advisors and disillusion with actively-managed fund fees have helped fuel the sector. In the specific context of China, the recent decision by market benchmark organisation MSCI to include mainland Chinese A-share equities into emerging market indices is also likely to fuel ETF growth.

But there are few nagging worries. For example, inflows of money into “passive” index funds has prompted concerns that these funds are distorting the very market they track. (See an article on this issue here.)

“Equity ETFs, to take that case, are still only 7 to 8 per cent of the whole global equity market,” Chris Pigott, senior vice president, BBH Hong Kong, told WealthBriefingAsia in a recent call about the firm’s report.

“We have had a long bull market, but ETF issuers are coming up with new products. These are not just passive Beta products: there are more active, factor-driven ones.” (He referred to ETFs in which the drivers of return, such as yield, valuae and momentum are decomposed so that investors can track them specifically.)

Such products mean investors have more ways of playing markets regardless of market direction, Pigott said.

Rationales for why ETFs grow and develop in Asia differ from country to country; there are differences which providers need to be aware of. Overall, however, the main drivers are the same across Asia: low cost, efficiency and transparency, Pigott continued.

The BBH survey found that 63 per cent of Greater China ETF investors surveyed plan to increase their ETF investment allocations in the next year. When looking solely at Mainland China, that number jumps to 77 per cent from 43 per cent in BBH’s 2018 survey.

BBH surveyed a total of 300 institutional investors, financial advisors, and fund managers from the US, Europe, and Greater China. Some 100 respondents represented Greater China including Mainland China, Hong Kong, and Taiwan.

Chinese investors don’t cite costs as a major reason to hold ETFs: defying global industry assumptions that cost is everything, expense ratio is near the bottom of the list of ETF selection criteria in Mainland China and Taiwan.

Historical performance and ETF issuer dominate investor thinking, the study found. Historical performance was cited as the most important selection criteria for investors in Hong Kong and Taiwan, a sentiment shared by US and European investors. The top drivers for ETF selection in Mainland China were ETF issuer and index methodology.

Smart beta ETFs are catching assets from mutual funds: 97 per cent of respondents in Greater China have at least one smart beta ETF in their portfolio and 38 per cent purchased a smart beta ETF in the last 12 months to replace an actively-managed mutual fund, the study showed.

BBH’s Pigott agrees with the suggestion that ETF providers will consolidate from what is a varied field. As well as continued listings, there are examples of de-listings where, for example, a new ETF hasn’t gotten much demand this is part of the learning process in a market.

In a sometimes crowded space there is a need for providers to differentiate, he said.