The experts summarise how to Choose an Asia-Pacific ETF

If you are considering your key investments you may have been drawn towards Asia Pacific markets, particularly Asia-Pacific ETFs. These invest in the equity of companies from Asia and the Pacific region. With 131 ETFs traded on the U.S. markets, Asia-Pacific ETFs have total assets under management of $80.87B.

But how do you choose an Asia Pacific ETF? The experts at Optilab Partners share their thoughts here….

If you want to invest in an Asia-Pacific market tracker, choose wisely. Actively managed funds may charge exorbitant fees. And what do you get for those fees? The fund will track a market index for you, and that’s about it.

ETFs offer cheaper and potentially more profitable access to Asia Pacific investing.

How do You Choose an Asia Pacific ETF?

 When you find an attractive ETF, consider the following before committing to it.

1. What is it tracking?

Some ETFs may appear to track similar selections of indexes. At a closer look, however, you can tell they are different beasts. In China, every fund tracks a different index.

Pay attention to the composition of constituents. Some ETFs may give you a disproportionately strong exposure to an industry or sector that presents no interest to you.

In Hong Kong, property and financials are strong industries. The MSCI Hong Kong reflects this status quo by relying on financials and property for 60% of its composition. This is not necessarily a problem if you don’t mind weak industry diversification.

Asia-Pacific ETFs are great for diversifying portfolios across countries and economic regions. They are less suited for industry-based diversification.

For more diversification, look to modern providers like MSCI. Traditional providers like The Strait Times Index and Hang Seng are even weaker diversification-wise. That said, it is possible that no provider can fulfill your diversification needs and expectations.

2. Be Aware that Some ETFs Pay Dividends while Others Capitalize Them

Dividend-paying ETFs hand you your money regularly. You can then decide what you want to do with it. You can re-invest it if you like or use it for something else. Other ETFs automatically roll your dividends into your investment. On the one hand, you don’t have to bother re-investing manually. On the other hand, such funds limit your access to liquidity.

3. Your ETF May Not Track an Index Closely

ETFs are less expensive than actively managed funds, remember? Some save costs by not buying all stocks from an index but rather a selection of them they deem representative.

Thus, the short-term evolution of the fund can diverge from that of the ETF. To some investors, this may be a surprise, and some may not even understand why that is the case.

Those planning to roll investments in and out of an ETF frequently should also consider the liquidity of the investment vehicle. People actively trade popular funds. And the spreads between the bid and ask prices are small.

Less popular ETFs feature larger spreads and are more expensive to trade actively. Such ETFs still work well for long-term investments, however.

4. Understand the Nature of the ETF

Not all ETFs are equal, and not all of them work similarly. Some hold the constituents of the underlying index. Others don’t.

• “In specie” ETFs are the “straightforward” ones. These ETFs hold the constituent securities of the index and reflect its price evolution closely.
• “Swap-based” ETFs are trickier. Instead of holding the underlying securities, such ETFs only have a swap contract with a counterparty. The contract compels them to pay losses if the index loses money or allows them to get paid if it gains. Swap-based ETFs do not offer direct exposure to the underlying index.

Major financial entities act as counterparties for ETF investments. The chance of such a counterparty collapsing is minimal. Even if only in theory, however, a counterparty collapse may happen. If it does, your ETF investments collapse with it.

To avoid even the theoretical possibility of a collapse, invest only through ETFs that hold their underlying securities.

5.  Leveraged ETFs

Leverage entails additional risk. It can also have some unexpected effects on long-term investments.

Some Chinese leveraged ETFs claim to deliver daily results, before other expenses, that correspond to the inverse of the Xinhua China 25 index times two.

Your returns on such an investment depend on the daily percentage moves. Over the longer term, the daily swings can create some unexpected results.

To avoid this problem, only use leveraged ETFs for short-term investments.

6. Currency Risks

Investing in Asia-Pacific is not simple by any means. You must consider every detail, and currency risks are not among the more obvious details.

Providers may price some ETFs in one currency while the ETF tracks the performance of a basket of stocks in another currency. The performance of the same index can differ depending on the currency in which one measures it. The return of iShares Japan ETF is different in USD and JPY.

Hong Kong, China, and Japan are the most obvious choices for investors looking for Asia-Pacific exposure. Looking past these markets has its merits, however. Indonesia is a promising market, though its ETF options are few. As more investors show interest, however, more options may surface.

India is also an attractive destination for ETF investments, though it too features limited choices for those looking for traditional exposure. Investors willing to explore fundamental indices may happen upon unexpected opportunities.