Emerging market index move may fall into liquidity trap

Exchange operators in Brazil, Russia, India, Hong Kong and South Africa will launch the trading of benchmark equity index futures across member countries, an initiative blessed by leaders of the countries at a summit in New Delhi.

The idea to give investors in one country exposure to another hot market in their local currency carries appeal, on paper at least.

However, investors won't buy into a financial product unless they are confident of liquidity, and that liquidity will not come unless investors buy in.

"Not many (investors) track other markets. Liquidity would remain a problem for these instruments on a perennial basis," said Ambareesh Baliga, chief operating officer of brokerage Way2Wealth.

Indian investors have seen this particular problem first hand.

An exchange traded fund (ETF) tracking the Hang Seng index, now called the Goldman Sachs Hang Seng Exchange Traded Scheme, was launched in early 2010 as a way for Indian investors to track a market that had surged 52% the previous year.

There has been one problem: The ETF had daily average volumes of 300,000 rupees this year as of Wednesday, according to Reuters calculations based on the daily data posted in the National Stock Exchange.

That's just about the cost of a Nano car from Tata Motors in some cities in India, despite a 13.3% gain in the Hang Seng in the same period, slightly higher than global indexes such as the S&P 500.

ETFs listed in Hong Kong have run into similar problems. Late last year, Lyxor International Asset Management, a unit of Societe Generale , delisted a number of products tracking global indexes, citing trading volume as one of the factors.

Solving the problem of liquidity would be key for the success of such investment vehicles, investors said, especially as exchanges plan to introduce products beyond index futures.

"These instruments should have some market-makers initiatives and enough information flow about cross-markets," Way2Wealth's Baliga said.