Switching Hong Kongers on to mutual funds

Sam Ip, head of Bank of East Asia''s unit trust agency department, explains why mutual fund uptake should grow.

Retail investors in Hong Kong tend to invest over very short periods of time and focus on investing in the stock markets, paying attention to price changes in order to make a profit. It is difficult to change their perceptions to view "long-term" investment as anything over three months - even with funds, investors tend to check the prices of mutual funds on a daily basis on the fund-houses' websites or in the newspaper.

As a result they have mainly avoided investing in mutual funds. Mutual funds primarily allow investors to diversify their assets, accessing a portfolio of different securities using a relatively small amount of money. Spreading your assets means spreading the risk, and thus reducing the chance that your investment could be lost.

Fund returns are increasingly attractive because interest rates are decreasing, making it harder to keep your money in the bank. Many stocks are also at very low levels after the volatility of the last year or so, which means that units of mutual funds are also priced at very low levels, making this a good time to buy both here and overseas.

Markets are also becoming increasingly complex and to make the right decisions, an investor needs to have access to huge amounts of information. For retail investors that do not have the time to sift through all the latest news on a company, this is clearly where fund managers and their teams of analysts can help.

Finally, investors have a greater degree of liquidity via mutual funds when they wish to dispose of their assets as they do not need to actively seek a buyer: fund management companies will redeem fund shares at the net asset value that same day.

In the past, retail investors have also had little information on mutual funds, but that is now changing. Information is available through financial publications such as Benchmark and fund rating agencies such as Standard & Poor's or Lipper, which have been active for a number of years. Well known international companies such as Morningstar are also opening in Hong Kong.

But the biggest boost of interest has been the Mandatory Provident Fund scheme (MPF). MPF is a scheme introduced by the government at the beginning of the year in response to the aging population. Its major aim is to ensure that workers have some money to fall back on when they retire, rather than rely solely on their families or the government.

Unlike the US 401(k) pension plan, however, there are no tax incentives encouraging people to make voluntary contributions to their MPF scheme, or to move money from other investments into MPF products. The lack of these benefits has meant that MPF was not the same catalyst as it has been in other countries where mutual funds are concerned.

Furthermore, fees put off many retail investors, who believe they can do better by directly investing in securities themselves (unaware of the losses they sustain do to volatility and transaction fees; nor do they understand the greater systemic risks they face, particularly due to lack of diversification). Not only do they have to pay when they put money into a fund (anything up to 6.5%), their invested amount is then subject to annual fees (1.25-1.75%) and custodian fees (0.10-0.55%). There may be a redemption fee as well.

In mature markets such as the United States, fund houses rely on performance fees due to the minimal or no front-end fees on funds. Hong Kong's industry will move in this direction, with banks in particular relying on either a trailer fee or simply using the provision of funds as a hook for other investment products as the markets develop. Lowering the cost of buying into funds logically will increase interest.

Interest should also be further stimulated by offering a greater range of funds that include exchange traded funds and index-linked funds to the general public.

Fortunately, the industry is transparent, which makes the crucial education process more easy. The Securities and Futures Commission has worked hard to ensure fund houses make their investment processes as clear as possible to investors. The fund rating agencies are now building feeds from their databases to investor websites.

The new Securities and Futures Bill will also help level the playing field by subjecting banks to regulation by the SFC for the first time, allowing it to ensure banks' front-line securities staff provide the highest quality of information and to scrutinize their procedures to a higher degree than under the Hong Kong Monetary Authority.

The theme behind all of these positive events is education. There must be more surrounding mutual funds' role as a useful savings tool, such as helping pay for your children s education, rather than marketing them solely as a way of providing income for retirement.

And in this process, banks offer a number of advantages over pure fund management companies in Hong Kong. First is the convenience of existing distribution networks; their history of relationships; a sense that banks are established and safe. Furthermore, banks can provide investors with integrated statements that give them a better overview of their financial situation. Last, banks can leverage their large capital bases to provide discounts and cross-sell other investments and services.

Banks in Hong Kong are working hard to ensure that investors will automatically consider mutual funds when deciding how to plan for their future financial obligations.  The first step is to ensure that investors have the relevant information to understand what their investments will achieve.

Sam KS Ip is head of the unit trust agency department at Bank of East Asia. The views expressed here are his own. E-mail: [email protected].

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