HSBC’s Vanguard-style ETFs open door to potential wave of imitators

The impending launch in Europe of a quartet of exchange traded funds could pave the way for a rapid expansion of Vanguard-style umbrella structures offering both ETFs and mutual funds.

The May launches from HSBC Asset Management will come in the same month that Vanguard loses its nationwide patent for the same structure in the US, potentially opening the floodgates to a range of imitators there — if regulators do not intervene.

The twin developments could usher in an era of wider choice for investors and lower costs as fund managers reap economies of scale and rotate to cheaper ways of distributing their funds.

HSBC AM said it had regulatory approval to launch Dublin-domiciled ETF share classes of four passive bond mutual funds with combined assets of $6bn. They will become the first funds to take advantage of a rule change allowing the umbrella structure, a decision taken by the Central Bank of Ireland, the country’s financial regulator, in 2018.

Although a handful of broadly similar structures have been set up in Luxembourg, Ireland is increasingly becoming the primary focus of Europe’s $1.5tn ETF industry, with two-thirds of assets domiciled there, magnifying the importance of HSBC’s rollout.

“As far as I’m aware this is the first time in Europe where someone has taken an existing Ucits fund and converted it to an ETF,” said Sean Tuffy, industry expert and former head of market and regulatory intelligence at Citigroup Securities Services.

“I have had conversations with Irish fund industry lawyers who say there are other people looking to do this. Asset managers are herd animals in a way, so it will be interesting to see if others follow suit,” Tuffy added.

“I think it’s a key moment,” said Adrian Whelan, global head of market intelligence at Brown Brothers Harriman. “We have never had a large asset manager renaming index funds and launching share classes in Ireland.”

“We have clients who are analysing this on an ongoing basis. HSBC are a brand name. I think this will give it impetus,” Whelan added.

The four funds gaining ETF share classes will be HSBC’s Global Government Bond Index Fund, Global Corporate Bond Index Fund, Global Sustainable Government Bond Index Fund and China Government Local Bond Index Fund.

In line with the CBI’s stipulations, each fund will be renamed with the words “Ucits ETF” added to their original titles. Even the continuing mutual funds will adopt this nomenclature because all share classes must have the same fund name.

Whelan believed this naming requirement, resulting in mutual funds being labelled ETFs, was one of the reasons why it had taken five years for an asset manager to make use of Ireland’s ETF-as-share-class provision.

Tuffy agreed, saying: “I always thought this [naming issue] would be the deal-breaker in terms of following this path.”

Under a quirk of the regulations, though, the $6bn at present held in the funds will catapult HSBC AM into the top 10 of bond ETF issuers in Europe when the ETF share classes list on May 18 — even if the ETF versions fail to attract a single cent. As of December 31, just $18bn of its $617bn worth of assets under management were in ETFs.

“This is a very clever way of having ETF assets while leveraging your mutual fund track record,” Whelan said.

Marco Montanari, global head of ETF and indexing capability at HSBC AM, said the move was in response to client demand: while some clients preferred mutual funds, “the global trend is that passive has been growing significantly. ETFs are the product that is raising the largest amount of assets.”

It would provide “additional flexibility to investors to build their portfolios. Whether it’s through economies of scale or the ability to trade freely in real time, these new listed share classes put investor choice at the front and centre of our index offering”, Montanari added.

The fact that the ETFs would start life with access to a multiyear performance record and large asset base provided further benefits “because many clients require a certain AUM to be able to invest in a fund”, he said.

His colleague, Olga de Tapia, HSBC AM’s global head of ETF and indexing sales, said the group had two investment platforms: “ETFs for equities and index funds for fixed income. We are not enabling clients to build multi-asset portfolios with the same type of instrument.”

This development will help correct that.

Annual management fees for the different share classes of the mutual fund versions of these four vehicles vary widely, from just 5 basis points to 55bp, whereas the ETF versions will be the same price — as yet undisclosed — for all investors.

HSBC is unlikely to stop at these first four funds, with Montanari adding that this was just “part of a larger programme”.

Tuffy expected more managers to follow suit “if they get comfortable from a distribution perspective and from a naming perspective”.

“I think there’s a pretty good chance we will see others follow HSBC. Whether it’s a stampede or just a couple of other big players we shall see,” he said.

However, HSBC’s gambit comes at a pivotal moment for the future of the ETF-as-share-class structure in the US.

Rival managers have filed with the Securities and Exchange Commission to copy Vanguard’s structure when the patent expires in May, but it is far from inevitable that the SEC will approve the applications, given the concerns it has flagged around conflicts of interest between share classes in the years since it gave Vanguard the go-ahead.