Edhec study explains hurdles to index product sales in Asia

European passive fund managers selling to Asia should concentrate above all else on transparency, liquidity, and offering more than just standard cap-weighted methodology products, suggests a study on index appetite in Asia by Edhec.

French business school’s survey in April/May 2011 of 127 Asian investors, from asset managers to professional fund buyers – mostly in Australia, Singapore and Hong Kong, only 4% in Japan – found these were the main requirements for the region.

Many fund selectors complain of the active fund industry’s mistakes and shortcomings, but Edhec’s research suggested the $6trn passive industry has room to improve, for Asian buyers at least.

“A generic index construction approach is not necessarily consistent with investor’s varying investment objectives, which can differ across asset classes or even across investors who invest in the same asset class,” the study’s authors noted.

“The challenge for indices in the future may be to find a better match between the requirements and objectives of investors and the properties of the indices and benchmarks they have at their disposal.”

Almost 90% of equity investors in the region had used indices to do so, and 71% were satisfied. For the 52% of government debt investors who invested partly passively, only 49% were satisfied, while 60% of those who used indices to do so were happy with them.

Passive fund sellers will have to tackle the major shortcomings of benchmarks, in the opinion of clients.

For equities, these are overinvestment in expensive stocks, poor diversification, sector and size biases, and lack of reflection of economic weight. For government fixed income problems are instability of duration, and inconsistent selection rules and non-systematic pricing. For corporate bonds, they are overinvestment in risky companies, lack of liquidity andunreliable credit exposure.

The study noted 88% of respondents wanted transparency of indices – “though numerous index providers do not provide free and easy access to the composition of their indices”.

In addition, about 60% of respondents see “significant problems” with standard cap-weighted equity indices, and only 17.6% believed there were no problems with such methodology, the main part of the passive industry.

As index providers are rushing to provide fixed income benchmarks that do not simply weigh issuers – sovereign or corporate – by the amount of debt they already owe, Edhec’s survey found fewer than half of Asian respondents were satisfied with the fixed income indices they are using.

Almost eight in every 10 respondents said corporate bond indices “lacked reliability” in terms of interest rate and credit risk.

When it comes to corporate benchmarks, most respondents like to have indexes segmented by maturity and credit rating, whereas for sovereign debt benchmarks a credit segmentation is critical.

For Asians, country-based indices appear to be more important than style indices tracking value, growth or income, for example.

Edhec pointed also to significant differences between Asian and European/American buyers, inasmuch as Asians “consider the risk-return properties of an index to be important when making the decision to adopt one”.

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