Exchange traded funds (ETFs) have an astonishing growth rate in Taiwan’s financial market in recent years, and have become an important instrument for general investors to participate in the investment market. ETFs and mutual funds are essentially the same, with the original purpose to help investors utilize limited capital to achieve risk diversification and asset allocation.
One major difference between ETFs and mutual funds is that mutual fund investors can only subscribe or redeem once a day with the fund issuing company at the net asset value by the end of the day, but ETFs are traded on the stock exchange, and investors may buy and sell ETFs real time at the market price.
Recently, Taiwanese regulator and financial industry are actively discussing the initiations of “active” ETFs and “multi-asset” ETFs to make the market’s ETF products more complete, which should be a good development for investors. Referrring to the development of global active ETFs in recent years, as of May 2024, the number of active ETFs worldwide has reached 2,612, and the asset size has reached a record high of NT$889 billion, with a growth rate of 20.3% from that at the end of 2023; the percentage of the total global ETF asset size also grew to 6.9% from 5.26% in 2022. In terms of compound annual growth rate in the past decade, it is as high as 39.3%, representing a type of ETF market that has developed quite rapidly.
The trading strategies of ETFs, like mutual funds, can also be classified into passive and active ones. Passive startegy completely replicate or simulate certain stock or bond indices as close as possible. That is to say, when the stock or bond constituents in the indices change in accordance with the original rules set, passive ETFs will change their constituent assets accordingly to make their performance closer to the indices tracked, the closer the better. Therefore, passive ETFs do not pursue excess returns, but try to simulate the returns of the indices they track as much as possible.
One characteristic of passive ETFs is that they must passively replace the assets they hold based on changes in the indices’ constituent assets. Moreover, the rules for determining the constituents of an index are set from the beginning, so professional asset managers or investors with information advantages cannot actively apply their potential information advantages to obtain potentially better returns than the index.
Active ETFs, on the other hand, are like active mutual funds which may adjust their constituent assets through fund managers’ judgments of future market trends, with the ultimate goal of creating higher returns than the indices based on information advantages. In addition, the transaction and management fees of ETFs are usually lower than those of mutual funds, and ETFs can be traded real time within a day, without being subject to restrictions of daily subscription or redemption.
In addition, it is well known that one characteristic of passive ETFs is that the index-tracking assets they hold are transparent and the information is publicly available, while the current global active ETFs also adopt a fully transparent framework as the mainstream trend. Although full transparency may allow other market participants to profit from the announcement on constituent assets, a phenomenon which can easily put ETFs at a relative disadvantage in terms of buying and selling prices at the conversion of constituent assets, open and transparent commodity information not only makes it easier for investors to adopt ETF products, but also enables liquidity providers to participate more efficiently, thus promoting active trading. Therefore, active ETFs in neighboring Asian countries such as South Korea, Japan and Australia are mainly fully transparent, and over 90% of the global active ETF assets also adopt a fully transparent structure.
In addition, the appropriate allocation of stocks and bonds can theoretically increase returns and reduce risks, making it an important diversification investment strategy. However, among the ETFs currently listed on the Taiwan market, there are only passive stock and bond ETFs, respectively. Therefore, if ETF investors would like to achieve an appropriate stock and bond allocation ratio, they must combine appropriate stock and bond ETFs by themselves, which will be a challenging task for those investors with limited financial knowledge.
Therefore, if a multi-asset ETF with mixed allocations in stocks and bonds can be allowed to let professional ETF managers assist investors in allocating different assets based on the ratio of stock and bond assets in the index tracked, it cannot only save investors time in asset allocations on their own, but also improve the allocation efficiency, which will greatly benefit investors’ returns and risk diversifications.