It can be expensive to live in Hong Kong, with costs now rising more sharply this year than in recent times. Unfortunately, that hefty price tag also applies to investing.
A Morningstar report showed that Hong Kong is ranked below average out of 26 markets in terms of fees and expenses. Morningstar commented that the median expense ratio for available-for-sale fixed income and equity products are among the highest in the study, although Hong Kong-domiciled funds are cheaper.
Here are four reasons why Hong Kong continues to score poorly in this aspect:
Restricted access to mutual funds
In Hong Kong, banks account for around 80% of total fund sales in Hong Kong. As the banks control the majority of access to the retail investors, they have huge bargaining power over the fund managers. According to Morningstar, the banks typically take up between 30 to 60% of the fund management fees as trailer fees.
Trailer fees make it difficult for fund managers to transfer any cost savings back to investors.
While there are low-cost, institutional share-class mutual funds available in Hong Kong, access to these funds is limited. These institutional-share classes of funds have traditionally been available only to private banking clients who park substantial assets with their private banks. This is even though such classes of funds are also available for sale to retail investors.
The Morningstar report also highlights that investing in ETFs in Hong Kong is still in its infancy, be it through the Stock Exchange of Hong Kong or through foreign-listed ETFs,
In Singapore, Endowus has opened up access to institutional-share classes of funds that do not charge retrocessions, to our clients. If only the retail tranche of a fund is available, then Endowus returns the embedded trailer fees to clients. The amount of trailer fees that Endowus has returned to customers since inception has now crossed $4 million.
Conflict of interest
As shown in the report, markets such as the Netherlands and many developed nations have lower median expense ratios, because any trailer-fee payment arranged between fund managers and distributors has been made illegal through an EU regulatory framework known as MiFID II (Markets in Financial Instruments Directive).
MiFID II was put in place to address a conflict of interest created by retrocession fees. The practice of earning retrocession or trailer fees leads to significant misalignment between the distributors and ordinary investors. Distributors are incentivised to push the products offering the highest trailer fees to the clients when in reality, investors would benefit from lower-cost products with zero or low trailer fees.
Endowus has run calculations to demonstrate the impact of trailer fees — it represents a looming opportunity cost for investors that have been kept hidden from view. If investors had invested between 1988 and 2021 and put that trailer fee to work in the markets instead of paying it to fund distributors, they would have earned another 290%. So $12,000 in 1998 should have snowballed to more than $100,000 by 2021 (or 780% in total returns).
Asymmetrical mutual fund performance fees
A performance fee is an additional payment made to a fund manager for generating positive returns, or for outperforming its benchmark. This is often on top of the fund management fee, which is charged on an ongoing basis. This adds to the total expense ratio of funds.
While performance fees align the interest between retail investors and fund managers, it can also lead to poor behaviour from the fund managers. Fund managers that are underperforming their benchmark before their end-of-year fee calculation are incentivised to take on additional risk in the hopes of rising above their benchmark.
Front-end load
Mutual fund investors are also typically charged a one-time fee when buying a fund. This sales charge is known as a front-end load, or more commonly subscription fees. Mutual fund sales charges vary between platforms and may be waived.
What contributes to the expensive investing options in Hong Kong is that banks continue to charge upfront sales charges, the Morningstar report said.
Time to end trailer fees
The Hong Kong fund industry is an expensive market because it is still distributor-controlled, with intermediaries such as banks, financial advisors and fund platforms charging high fees when set in a global context.
Tackling the high costs of investing is one big reason why Endowus came into being.
It is possible for advisors and fund distributors to offer lower cost funds and to open up access to low-cost funds so that retail investors can enjoy a higher chance of success in building long-term wealth.
Endowus wants to move towards global standards in lowering investing expenses, by charging fair and transparent fees to stay aligned to retail customers’ interests.
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