Smart beta's Asian push will cut pension fees in Hong Kong

Felix Xu


Smart beta is growing in Asia and its growth could help lower the management fees of Hong Kong pension funds, Felix Xu writes.

Smart beta has been the watch-word of index investing in 2017 - and it's surging in the Asian pension market, like elsewhere.

US-based Franklin Templeton recently introduced the first smart beta strategy to Hong Kong's largest compulsory retirement programme, the Mandatory Provident Fund scheme.

Established in 2000, the defined contribution MPF scheme has registered an annualised internal rate of return of about 4% as at June 2017, with total assets of around HK$743.73 billion (US$95.32 billion).

The scheme has long been criticised for its high management fees and its relatively low historical return compared to local inflation.

The criticism has led the supervisory body of the MPF industry, the Mandatory Provident Fund Scheme Authority (MPFA), to speed up management fee reform, planning to cut the average management fee to 1% in three years from the current 1.57%.

From the MPF provider perspective, the 18 registered MPF trustees in Hong Kong are putting more effort to bring in new investment choices so as to secure more market share.

In this context, passive investing is seen as one of the key market trends for cost-effectiveness.

Whether smart beta can address the MPF deficiencies remains to be seen, but the rules-based index structured investment strategy will definitely give MPF members another option that enables them to allocate their retirement contribution in a more transparent way.

Franklin Templeton said that it decided to launch its smart beta strategy "to tap into the growing popularity of smart beta products."

The strategy uses a quantitative, proprietary and rules-based index methodology and selects stocks that have exposure in four investment factors: quality (40%), value (40%), momentum (10%), and low volatility (10%).

David Chang, Franklin's regional head for Greater China, notes that "the strategy offers a unique solution for investors who want to gain exposure to Hong Kong equities via a systematic and low-cost approach that harnesses the best of both active and passive investing."

In fact, passive investment solutions have been in place in the MPF market for many years.

In 1998, the Hong Kong Government acquired a substantial portfolio of Hong Kong shares to stabilise the market during the Asian financial crisis.

The government then wrapped its shareholdings in the form of ETF, the Tracker Fund of Hong Kong, and listed the fund on the Hong Kong Stock Exchange as the first step of its disposal programme.

The Tracker Fund was subsequently available on a number of MPF platforms. Currently, there have been about 100 index-tracking collective investment schemes in the market.

Having said that, MPF schemes have yet to be allowed to directly invest in ETFs for investor protection reasons. Pension industry representatives are calling on the regulator to loosen the straitjacket.

KP Luk, head of Hong Kong defined contribution business at Fidelity International and executive committee member of Hong Kong Investment Funds Association, previously urged the Securities & Futures Commission, the financial regulatory body in Hong Kong, to incorporate ETF and real estate investment trusts (REITs) in MPF platform so as to provide more investment options to the members.

However, Hong Kong-based financial service provider Nobel Apex Advisors, said in a commentary piece that retail investors in Hong Kong have very limited understanding of ETFs because they represent a small transaction volume in local stock market.

"As such, the industry has to reinforce investor education if they want to include ETF in the MPF plaform," it says.

Apart from public pension fund, Hong Kong's private pension schemes have put more emphasis on smart beta strategies recently.

For example, Hospital Authority Provident Fund Scheme, the largest defined benefit pension plan in Hong Kong, launched its first smart beta strategy, which tracks the Russell 100 Low Volatility Index, in 2016 and appointed BlackRock to manage the mandate.

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