Hong Kong is an exciting place for investors to use ETFs. With the proliferation of new products, investors are spoiled for choice.
We will be discussing ETFs and ITFs in this article. Follow this link to learn more about ETF selections. Many people ask, “how do I select ETFs?” or “what should I look out for when selecting ETFs?”
We want to introduce some important factors that investors should consider when choosing between different ETFs in Hong Kong. As you know, not all ETFs are born equal. Some follow a specific index, while others aim at market cap or use fundamental analysis to construct the portfolio.
The latter two are actively managed and will incur higher management fees when compared with passive index-tracking ETFs.
Active managers may use various top-down or bottom-up stock picking, macroeconomic sector rotation, or fundamental research to achieve outperformance over their benchmark.
What is a Hong Kong ETF?
An Exchange Traded Fund (ETF) is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an Index Tracking Fund (ITF).
Unlike mutual funds, which you can only trade at the end of the day when its net asset value is calculated and published, ETFs can be bought and sold throughout the trading day at their current price. This characteristic is ETFs’ most attractive feature.
Index Tracking Funds (ITFs)
Index Tracking Funds are funds that aim to replicate the performance of an index. They do this by holding the constituent securities of the benchmark index in roughly the same proportion as its market capitalization.
This ensures that their performance closely tracks that of their respective benchmark indices. ITFs should be low-cost due to their passive investing strategy. It can expose investors to a particular index, such as Hang Seng Index. MSCI China or MSCI Hong Kong via physical delivery or Synthetic Replication for US Dollar denominated indices.
These funds often track an entire country’s stock market, so you may not need to hold multiple ITFs to gain exposure to different markets. For example, if you want exposure to China and Japan, and Korea, you can include all three countries in a single holding.
The higher the expense ratio, the lower your net return will be. ETFs usually have an annualized fee of below 0.5%.
Index tracking funds have very low turnover ratios, so they are tax-efficient for investors subject to capital gains tax at a 15% rate or above on their marginal income tax rates.
Exchange-Traded Funds (ETFs)
ETFs are index-tracking funds that trade intraday on stock exchanges just like individual stocks instead of being bought and sold at the end of each trading day like mutual funds.
Because of their unique investment structure. ETFs provide many benefits that traditional index funds do not offer, such as liquidity and trade-ability. This characteristic of ETFs makes them very popular among investors. ETFs can be structured to track an index or a commodity and may use physical or synthetic replication.
Physical replication is the process of buying all the components in the underlying index. In contrast, Synthetic Replication is a form of active management where derivatives such as swaps and futures contracts are used to obtain market exposure for greater efficiency and economy than would be achieved by holding each component directly.
Instead of holding individual stocks, ETF providers often use this approach to minimize risk and reduce trading costs. Resulting in lower expenses for the end investor. Popular indices tracked by equities-based (physical replication) Exchange Traded Funds (ETFs) include MSCI World, Hang Seng, Nikkei, and FTSE 100.
For ETFs tracking stock indices in foreign countries such as China, Japan, and Korea. Investors can buy these Index Tracking Funds (ETFs) on HKEx and SGX. They can then trade them like individual stocks to benefit from the lower cost of trading ITFs than investing directly in those markets.
Traders can include all three markets in a single holding through ITF products.