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Article | MPFexpress

An overview of passive fund options in MPF

By Elaine Hwang | October 20, 2021

In recent years, passive funds have gained more attention within the MPF system, with members being attracted by their low management fees. This article discusses what you should know about passive funds.

In recent years, passive funds have gained more attention within the MPF system, with members being attracted by their low management fees. This type of fund does not aim to outperform the market in a particular asset class. Instead, the fund manager constructs a portfolio of securities very similar to the underlying index and, by doing so, effectively replicates the investment performance of the index.

The choice of investment funds within the MPF system is currently dominated by active funds but, as members demand more choice in the area of passive funds, we believe that MPF providers will be more willing to broaden their passive fund options.

Various passive funds are currently available within the MPF system

Among the passive fund options currently available in the MPF market, 12 funds track the Hong Kong equity market. Of the 12 funds, most track the Hang Seng Index, whereas a few track other indices, such as the FTSE MPF Hong Kong Index. The main reason why the Hang Seng Index has become a major benchmark is that its components are local stocks that are liquid and are actively traded. It is also an index which is well known and familiar amongst Hong Kong people. In terms of other passively managed investment funds, there are also funds that track regional indices, such as the Hang Seng China Enterprise Index and the FTSE Mandatory Provident Fund North America Index.

According to our internal research, the five-year median return net of fees for passively managed Hong Kong equity funds is around 9.1% per annum, whilst the corresponding figure for active funds is 11.9% per annum. Since passive funds do not seek to exceed market performance, the corresponding investment returns are often lower than the best performing active funds, but could be better than some poorly performed actively managed funds. Further, in terms of management fees, the average for passive funds is 0.9%, while the average for active funds is 1.6%.

Fund performance is determined by the tracking error

Passive funds generally charge lower fees because they can save in the areas of research and analysis of individual stocks, one of the main expenses for actively managed funds. For passive funds, the investment portfolio needs to replicate, as close as possible, the component stocks of the index, although achieving this is not as simple as one might imagine.

When the component stocks in the index change, or when there are other technical changes such as a stocks going “ex-dividend”, the passive fund must make similar changes to maintain the same position as the benchmark index. The approach taken to handle these situations directly affects the performance of the passive funds. The "tracking error" is a commonly used indicator to measure the performance of the passive fund manager against the benchmark index. The lower the level of tracking error, the more closely the fund follows the benchmark index.

Size of fund and execution powers affect the tracking error

The two factors that affect the tracking error are the size of the fund and the ability to execute transactions. If the size of the fund is too small, the performance of the fund could be affected by fixed operating costs, which would increase the tracking error. If the size of the fund is very large, it may mean having to buy large quantities of a stock, possibly affecting the average execution price.

Efficient trading is an important factor and so fund managers need to have access to an experienced execution broker.

Although passive fund managers are not required to make their own investment choices, passively managed equity funds should still be regarded as higher-risk investments, and the risk level is almost the same as that of active funds. If active fund performance does not meet expectations, and the extra management fees paid fail to create value-for-money returns, one may instead consider lower cost passive funds.

This article in English and Chinese is available for download.

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Senior Director & Business Development Lead, Greater China

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