Cerulli chronicles Japan’s ETF industry

Jul 24th, 2019 | By | Category: ETF and Index News

Exchange-traded funds in Japan more than tripled their assets in five years between 2014 and 2018 to ¥33.6 trillion (US$304.4 billion). Although institutional investors account for the bulk of assets, retail participation is set to grow with industry efforts to increase the availability of low-cost products, and foreign managers stand to benefit.

Cerulli chronicles Japan's ETF industry

Japan’s ETF assets rose further to ¥35 trillion as of June 2019, while the number of ETFs listed on the Tokyo Stock Exchange (TSE) reached 234 as of July 2019.

Institutions, mainly financial institutions such as the Bank of Japan, which started purchasing ETFs in 2010 as a monetary policy tool, represent 93.9% of total assets. Financial institutions started purchasing more ETFs after 2012, with more positive investor sentiment toward equity investments following the Lehman crisis.

Individual investors represent only 2.7% of total ETF assets. There are industry efforts to increase the availability of low-cost products to ordinary individual investors for long-term investments. In July 2018, the TSE introduced the Market Making Incentive Scheme (MMIS) to improve the liquidity of ETFs. A year later, version 2.0 of the MMIS was launched, with the aim of developing “star” ETFs.

Another way of promoting ETFs to retail investors is through ETF-incorporated mutual funds. With the trend towards passive products and diversification, more managers are becoming interested in including overseas ETFs within their funds as cost-efficient solutions.

ETFs are used in multi-asset funds or fund wrap programs, as well as on robo-advisor platforms, which are becoming popular with young investors. With online distribution becoming an effective tool for mutual fund sales, robo-advisors using ETFs in constructing portfolios for investors have a role to play. However, large domestic asset managers with extensive distribution channels still have an advantage over robos, whose assets are still small.

Foreign managers stand to benefit from industry efforts to grow the ETF segment. The MMIS, for example, eases the entry of offshore managers into the market, as companies that want to be designated as market makers can register with the Financial Services Agency (FSA), regardless of where they are headquartered. As of July 2019, seven firms were registered as market makers, and more are awaiting approval from the FSA.

Further opportunities for managers came in May this year when China and Japan announced the launch of a cross-border investment scheme linking both markets through ETFs. Under the east-bound leg of the Sino-Japan ETF Connect, Chinese fund managers can set up Shanghai-traded ETFs that invest, through the Qualified Domestic Institutional Investor (QDII) scheme, at least 90% of assets in Japan ETFs that track Japanese stock indices.

While existing foreign ETF managers tend to focus on institutions, some see long-term prospects in the retail market, where investors are becoming more cost-conscious. “With the growth in the number of ETFs, product differentiation will become increasingly difficult. Moreover, it takes time to build the business, as margins are thin,” says Ken Yap, managing director, Asia at Cerulli Associates. “For asset managers, efforts to reduce the costs of investing in ETFs, in order to provide higher total returns for investors, will become more critical than ever.”

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