This article first appeared in Personal Wealth, The Edge Malaysia Weekly on January 29, 2018 - February 4, 2018

Malaysians can expect to see the listing of several exchange-traded funds (ETFs) on Bursa Malaysia this year. A large contributor to these listings is i-VCAP Management Sdn Bhd, which launched its fifth ETF early this month, on the same day it announced that it was planning to launch up to six more this year.

This is part of an aggressive push by the company to promote ETFs to Malaysian investors, in line with their growing popularity as a cheaper investing option the world over. According to research firm ETFGI, global ETF assets totalled US$4.6 trillion last year, growing by more than a trillion dollars from 2016.

i-VCAP is currently the biggest ETF provider in the country. It is a wholly-owned subsidiary of ValueCAP Sdn Bhd, which is equally owned by Khazanah Nasional Bhd, Kumpulan Wang Persaraan (Diperbadankan) and Permodalan Nasional Bhd.

This gives its newly minted CEO, Khairi Shahrin Arief Baki, plenty to do this year. He says from his experience of working in equities, he has observed a trend towards passive strategies like ETFs in the international markets.

“The landscape has changed, the way people do business has also changed. If you look at Wealthfront, Betterment or Charles Schwab in the US, they have all gone into robo-advisory and where do they put their money? In ETFs. People have actually shifted towards a more passive way of investing,” he comments.

“I believe this is the right time. We have had five products in the last 10 years and now we’re going to double it in just one year. That in itself is a huge task and that’s why we have to work together. For this to be a successful year, we have to come up with something that the market really wants.”

This is why i-VCAP chose to kick off the year with MyETF Dow Jones Islamic Market US Titans 50 (MyETF-US50), the first US dollar-denominated shariah-compliant security to be listed on Bursa. As its name implies, MyETF-US50 will track the Dow Jones Islamic Market US Titans 50. The latter, in turn, tracks 50 shariah-compliant US blue chips and is highly correlated to the S&P 500 Index, providing investors with a chance to gain exposure to such companies as Apple Inc, Microsoft Corp, Facebook Inc and Alphabet Inc at one go.

“The S&P 500 achieved a return of 19.4% last year and has a projected earnings per share growth of 15% this year. While valuations appear to be elevated relative to historical levels, we believe this has yet to factor in the potential impact of US President Donald Trump’s policy initiatives, such as a reduction in regulatory burden and lower corporate taxes. The proposed reduction in corporate tax to 21% could lift the S&P 500’s EPS by a further 7% to 9%,” Khairi said during the launch of MyETF-US50.

The US$500 million ETF will be listed at US$1 on Feb 28 with a total annual fee of 0.475%. The initial public offering will be on Feb 9. The ETF will be rebalanced semi-annually and selected purely by market capitalisation. The underlying index of Dow Jones was selected because it closely tracks the S&P 500. Investors can access the ETF through any brokerage firm that has a multi-currency platform.

“Before we decide on an index, we normally perform a back test and send out our request for proposal to index providers. They come back with some prototype and we will do our analysis. This index tracks the US market quite well, which means its beta is very close to that of the S&P 500. If you’re talking about investors who like US equities in their portfolio, they can use this as a beta for the stock market, and do stock picking to get the alpha,” says Khairi.

In recent years, the growing interest in ETFs has stemmed from the low fees and the diverse exposure they offer investors in terms of geography and specific themes. A 2016 study by S&P 500 shows that 99% of actively managed US equity funds sold in Europe have failed to beat the S&P 500 in the last decade, and only two out of 100 global equity funds have beaten the S&P Global 1200 since 2006.

The first ETF listing in Malaysia was in 2005. According to the Securities Commission Malaysia (SC), the total number of ETF units outstanding as at end-November 2017 was

1,707 million with a market capitalisation of roughly RM1.9 billion. The growth of volume and value traded year on year, however, has been slow. Last year, the SC introduced a number of guidelines to spur the growth of the ETF market — it lowered the minimum capital requirement for ETF issuers and reduced the time to market in the issuance process.

The regulator also launched a framework for robo-advisors last year with licences for the Digital Investment Framework Management to be issued in the middle of this year. These moves are in line with Khairi’s vision of i-VCAP, which had assets under management of RM1.33 billion as at end-December 2017.

“Back in 2016, the SC brought in some speakers from robo-advisory companies (to the SCxSC conference), so we were already talking about ETFs but we didn’t have the ecosystem here. That’s why fund managers still like to pick stocks the traditional way. But once the SC announces guidelines for robo-advisors, demand will pick up. To do robo-advisory, you need ETFs,” he says.

The role of robo-advisors and ETFs in shaping a more technology-based and accessible asset management industry is already evident in many developed markets. This is something Khairi wants to see in Malaysia as well, especially as the younger generation will prefer more tech-savvy platforms in the future.

“It’s a different world out there. That’s what I told management during my interview with the group CEO, chairman and directors. Technology is the way to go, robo-advisors are really popular out there.”

Another trend Khairi has noticed is the use of micro-investing through apps, where one can invest as little as RM5 a month. He says the younger generation are already tech-savvy and may prefer to use their smartphones to invest.

“We would like to look at that space in the near future. There are just 20 of us here, so we need a technology partner. After that, we don’t need any branches or bricks and mortar and things like that. Everybody can download our app or go to our website and register, and start to invest because it is all online.”

Nevertheless, iVCAP’s push for ETFs comes when some observers in the global industry have cautioned investors against the risks posed by ETFs. Bank of America Merrill Lynch warned last July that the influx of ETFs was distorting the stock market by skewing the number of actual shares available. And if there is a market correction, investors may face problems in liquidating their ETF positions.

Khairi, however, says it is a matter of perception.

“At the moment, the ETF market is still relatively small compared with mutual funds. It is only about a quarter [the size] of mutual funds. As at end-2017, the global ETF market stood at US$4.6 trillion with 5,400 issuances while the US mutual fund market stood at US$16.4 trillion with 9,511 funds. Most mutual funds also invest in the same stocks. Money outflow from mutual funds to ETFs is due to costs. Also, if the market drops, the whole industry, including mutual funds, will drop.

“No doubt, the risk is higher for investors trading during the major rebalancing periods of ETFs in the developed markets. But based on the current size of the local ETF market, the impact may be negligible at this point in time.”

There have also been concerns about how ETFs make investors put money in big companies instead of those with good fundamentals, thus exposing them to high risk. According to Khairi, a variety of ETFs in the market can help prevent that from happening. “For example, there is alternative weighting, non-large cap exposure, smart beta or factor-based ETFs, which systematically capture the fundamentals of a company. Thus, it is important for the market to grow and offer ETFs that are structured differently or with different underlying assets or exposure,” he says.

A wealth of experience

Khairi’s observations on the changing investing landscape come from his 14 years of working at several brokerage firms. His most recent post was as the senior director and head of dealing, equity markets, at MIDF Amanah Investment Bank.

Before that, he worked at Citigroup Global Markets, JP Morgan Securities, Maybank Investment Bank and OSK Investment Bank, involved mostly in institutional equity sales and business development.

After graduation, Khairi worked in customer service for six months before joining OSK. While the two industries were vastly different, some of the skills he had to perfect remained the same.

“I always say broking is an overpaid customer service job because as brokers, you still pick up the phone to talk to customers, except that the clients on the other side are fund managers. I started with OSK and spent about five years there, learning a lot. I remember even going to places like the canteen of a post office, setting up a table and handing out account-opening forms to people,” he says.

His dealings in equities familiarised him with shariah-compliant and fundamental stocks. He remembers writing a light-hearted, year-end note to his clients when he was with Citigroup, asking them which stocks they would consider for the following year.

“Why don’t you look at your daily life from the moment you get up in the morning? If you are female, what facial cleanser, perfume, shoes or bags do you use? Look at your phone. Are you a Samsung or Apple person? Do you switch on the TV? Are you on Netflix or Astro? Later in the morning, you pick up a cup of coffee. Are you a Starbucks person? Then you commute to work. Some people drive different cars and some take the MRT.

“I wrote to clients, saying that sometimes you need to look at the products you use. And if you are comfortable with them, believe in them and recommend them to your friends, they should be on your list of stocks. That should be the way you look at how you want to invest as well,” Khairi says.

He took up i-VCAP’s offer — his first job on the buy side — because he was looking for a bigger role with more challenges.

“I had worked for an independent company, a big government-linked company, a not-so-big government-linked company and some big global names. All that experience helped shape me to take on this new challenge. Of course, I had been on the sell side for 14 years, but I would say as CEO, it’s very much about sales, business development and holding up the team,” he says.

In his previous jobs, Khairi’s clients were mainly the country’s major institutional investors, connections that he hopes will help him in guiding i-VCAP through its new phase of growth as most of the ETF volume and value traded is expected to come from them.

“Because of our capital market blueprint, 75% of our market trade value is controlled by institutional investors. So, we have study what sort of investments to look at as they would be our key clients. That would be the way for us going forward.

“We have big insurance companies, big pension funds and big unit trust companies as well. For example, if their recent products are aimed at China, that’s also where we want to look, so they can buy those ETFs as their core investment,” he says.

Bespoke ETF products can also be created for institutional clients but as they will be listed on Bursa, retail investors can also participate. i-VCAP’s target breakdown of investor participation is 75% institutional and 25% retail, in line with Bursa’s.

Building appetite for ETFs

When i-VCAP launched MyETF-US50, Khairi says he had to explain what ETFs were to many of his friends. Thus, the company plans to launch more educational campaigns this year concurrently with its new ETFs to raise investor awareness of these passive investments.

“We are definitely going to work with both Bursa and the SC. We plan to talk to the students and lecturers of business and accounting faculties at universities because they need to be aware of ETFs. The students need to know about ETFs before they enter the market, not only because they will be working in the financial line but also because they could be potential investors,” Khairi says.

Other than institutional investors, i-VCAP will also be targeting sophisticated clients, he adds.

“Because of their background and education, it would be easier for them to understand ETFs. They can read a few articles and get the picture. In terms of education, first it will be the financial people, then the more sophisticated investors, which is the group private bankers cover, as well as financial advisors because they cover a range of high-net-worth individuals.”

The launch of different ETFs is expected to spur investor interest in Malaysia. In fact, the SC announced early last year that local investors could expect to trade physically backed commodity, smart beta, leveraged and inverse ETFs this year.

Apart from MyETF-US50, i-VCAP has four other ETFs in its stable. Its first, the Dow Jones Islamic Market Malaysia Titans 25, was launched in 2008 and has seen an annual growth of 10% to 12%. Its MSCI Malaysia Islamic Dividend ETF has grown more than 15% a year while its MSCI Southeast Asia Islamic Dividend ETF and Thomson Reuters Asia-Pacific ex Japan Islamic agribusiness ETF have seen a less than 5% growth due to the appreciation of the ringgit.

The tracking error of i-VCAP’s funds has been below 3% so far, which is the company’s target. However, this is higher than the industry average of global ETFs, remarks Khairi.

“This is because in the more developed markets, they can do securities borrowing and lending, they can lend out the underlying shares of the stocks in the fund, so they get fees, which cover part of the expense ratio. That’s why their tracking is very close (to the benchmark) because their performance is not eaten up by expenses. But with the introduction of Bursa’s Islamic Securities Selling and Buying Negotiated Transaction framework, and as a shariah compliant fund, we can now do lending,” he says, adding that this can help reduce the tracking error of i-VCAP’s funds.

Khairi says the company has not firmed up the themes of the upcoming ETFs but has a rough idea of the areas it is interested in.

“We need more options now. For example, not everybody wants to go into the US. Some might want to go into China, so we are looking at that. That probably would not be just one but two different funds because even for China, it depends on whether you are talking about China or Greater China. We haven’t decided what the six ETFs will track yet but China will definitely be there.

“I’m inclined towards technology, so in the US, you can do something like Nasdaq, for instance. It has been performing well and there are a lot of names there that people would really love to invest in. We are also looking at Japan and we would like to look at thematic ETFs as well. It’s not easy to sell ETFs compared with other products, so we have to go for the ones that attract interest.”

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