Five years ago this March marked the start of large-scale protests which rocked Hong Kong for several months, destroying Beijing’s trust in the political loyalty of its Special Administrative Region. Subsequent security laws broadly diminished Hong Kong’s longstanding reputation for openness, setting off a competition among alternate locations to replace its role as a financial hub.

Since that time, it has become clear that Hong Kong will have no single replacement. Taiwan has aimed to use its geographic proximity and linguistic connection, as well as industrial excellence, to springboard itself into this position – but these are only very partial factors for success. “Taiwan is important, is very well positioned, and has an opportunity to grow, but it is against a backdrop of focused, growing competitors,” said George H. Walker, CEO of Neuberger Berman, a global asset management company with strong presence in Taiwan.

The contenders are diverse. “It is an exceptionally competitive environment right now. Singapore has done an exceptional job over the past 20 years of positioning itself well. Dubai, which would not have been on our list of important global financial centers 10 years ago, is investing massively in racing to the fore. Japan has done an exceptional job of driving structural reform to make Tokyo more important.” Taiwan will need to be keenly aware of these success stories as it seeks to upgrade its asset management industry – and Japan’s case will be a particularly relevant reference point, due to certain institutional similarities.

Overshadowed by a larger neighbor

In Japan 20 years ago, as Walker describes it, “products were sold, not bought.” Wealth management was characterized by high broker fees, as well as high portfolio churn rates. Individuals put most of their money into either low-yielding bank deposits or real estate, while unwieldy conglomerates notoriously kept large pools of unproductive cash on their balance sheets.

That was however before it made the strategic decision to transform its markets. “Japan was exceptionally late at changing, but it’s changing quite quickly.” Walker points to three major facets of this transformation. The first was simply the talent of regulators to deeply understand the investor experience with a longer-term perspective, applying pressure on all links in the investment value chain to modernize the whole process.

Second, through its Nippon Individual Savings Account (NISA) program, the government has encouraged private savers to participate more in the real economy. And finally, it has combined a top-down approach toward capital market management with bottom-up free markets, giving play to the advantages of both. As part of the structural reform arrow of “Abenomics,” the stock exchange made a point of “naming and shaming” stocks with particularly low returns on equity, encouraging better governance starting from important market institutions. “They have a long way to go on each of those scores, but the direction of travel is impressive indeed.”

Taiwan, for its part, has several strong points relative to Japan, perhaps arising from its historical dependence on SMEs as a growth engine. These include somewhat better governance, as well as more developed savings and capital markets; still, world-class technical expertise within individual businesses is where Taiwan truly shines. “Taiwan is an exceptionally important location for investment – many of the world’s leading companies are there, in some of the most important industries in the world – and it is blessed with a very high savings rate, with a strong financial system and strong domestic players.”

ETFs are just a wrapper

The move toward passive wealth management which has swept the market in recent years has undoubtedly helped democratize investment to certain groups, but it also has definite trade-offs. “In the ETF, it’s really just the wrapper that we’ve changed and improved. The substance, the stuff in the bottle, is still the same,” said Walker.

“If you don’t need to know that Coca-Cola is a soft drink company to decide how much to purchase, the chances that you’re going to have an impactful discussion with their management team, their board, and others are remote,” he said. Moreover, “if you frankly charge one or two basis points for the investment, it’s very hard to have a serious, engaged discussion.”

In this light, one could point out the particular irony in the mass popularization of ESG principles through passive vehicles. Despite the ethos of greater control through capital shareholding, active investors or mutual fund managers were replaced by the thin supervisory role of index providers and fund managers whose attention is spread across the entire market, creating few opportunities for knowledge transfer from investors to management.

The long-term consequences of this narrowing are felt not just by companies, but also investors. The rise of the “magnificent seven” in US stock markets this year can be blamed in part on index-based portfolio allocation. The majority of growth in 2023 took place in seven stocks: Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla. Although there is a coherent story for this phenomenon based on AI fundamentals, the liquidity of passive investment may have exacerbated this concentration, which could leave investors vulnerable to sudden pullbacks. A similar situation has also occurred recently in Taiwan, also driven by an AI investment thesis.

“For a capitalist system to work, you need owners to behave like owners,” Walker said. He foresees a similar “wrapper” structure for private equity and credit becoming more mature in Taiwan, complementing the ETF craze. This would allow patient retail investors to access a new asset class, participate more deeply in governance, and access the growth potential of the real economy, which is the true value of a thriving asset management sector.

This transformation will likely take place just as a similar one in Japan did, starting with competent regulators considering the entire value chain from all perspectives in order to drive a new vision to fruition. If Taiwan lacks this ambition, others will surely not.