China's active aversion hinders foreign players

The hostile response by China’s top-tier banks to the launch in August of multiple-client segregated accounts (MCSAs) has presented smaller regional banks with a valuable opportunity to increase their share of financial product distribution in the Rmb2250bn ($329bn) mutual fund industry, according to Shanghai-based investment consultants, Z-Ben Advisors. In a dispute over performance fee-sharing arrangements, six of China’s biggest commercial banks recently refused to sell newly-approved MCSAs, save for their own fund management company subsidiaries. ICBC, the largest fund distributor, also stopped selling public mutual funds for 44 days. Such is their stranglehold on fund distribution that China’s leading banks are used to dictating sales terms. ICBC and China Construction Bank command a combined market share of approximately 60 per cent, while Agricultural Bank of China and Bank of China account for another 20 per cent. MCSAs operate as managed accounts, each of which can raise capital from up to 200 investors. Each client must invest a minimum of Rmb1bn per fund product and each product must be worth at least Rmb50m. When the big guns imposed their temporary boycott, Z-Ben says smaller regional banks including Everbright Bank, Postal Savings Bank of China and Shenzhen Development Bank wasted no time in signing up to distribute MCSAs. More regional banks are now applying for distribution licences. However, while fund managers might benefit from their ability to negotiate lower distribution fees, Z-Ben warns that China’s smaller banks lack the extensive branch network and manpower of their larger rivals. New MCSA products had amassed Rmb10bn of assets under management by mid-October. The majority of the 70 products launched to date are balanced funds. The exceptions include two Sino-foreign joint venture fund management companies with ICBC Credit Suisse rolling out a fixed income product and Harvest launching two inflation-hedging funds. Z-Ben detects little interest – apart from the Sino-foreign JV asset managers, Fortis Haitong and Fortune SGAM – in launching MCSA products which invest in overseas assets through the Qualified Domestic Institutional Investor (QDII) scheme. Pointing out that a single QDII MCSA product could raise up to Rmb500m, Z-Ben says any foreign asset manager (with available QDII quota) with a suitable investment plan stands a good chance of winning business. But while MCSAs are considered to have strong asset-gathering potential, fund managers are advised that set-up costs could be onerous, given that China’s securities regulator, the CSRC, requires MCSAs to have a dedicated investment team and one that is completely separate from the mutual funds’ investment operations. In October China’s State Administration of Foreign Exchange (Safe) resumed granting QDII quota to investment firms after a long interval. With international stock markets continuing to rally coupled with Z-Ben’s prediction that the proportion of Chinese mutual fund industry assets dedicated to offshore investing will rise from 3 per cent at end-Q3 to 7 per cent by end-2010, the future would appear to be rosy for foreign asset managers. Instead, they face fewer opportunities to win active sub-advisory mandates in China as local fund managers look to passive products for overseas investment. Bosera is one of three fund management companies taking part in a Shanghai Stock Exchange-sponsored programme to develop Shanghai-listed global exchange-traded funds (ETFs). Z-Ben believes that at least four ETF providers – iShares, Deutsche Bank, Invesco and Nikko Asset Management – would be well-received by the SSE should they express an interest in co-operating to promote the development of global ETFs in China. Other cited contenders include State Street Global Advisors, Vanguard, ProShares and Nomura Asset Management. None of the latter currently has an ownership stake in a Chinese fund management company. The move is partly a reaction to the steep losses suffered by Chinese investors in international equities last year and in early 2009. Market liberalisation led to a wall of money allocated to funds investing internationally at what turned out to be a high point in stock market valuations back in 2007. Consequently, as distributors and fund managers in China reconsider international investing, some are questioning whether an active approach is required in certain markets in an industry with high fund distribution costs. Chinese asset managers found out when the downturn struck that they lacked the expertise to understand a wide range of international asset classes and investment strategies, believes Mark Konyn, managing director of RCM in Hong Kong. Therefore, they decided it would be easier to explain to their clients how an index-tracking fund works. Z-Ben says the popularity of passive products in 2009 is evidenced by “a glut” of funds tracking the benchmark CSI 300 Index – 15 in all and more in the pipeline. The volume of assets going into index-trackers increased steadily to the point where net inflows reached Rmb20bn in Q3 as active equity funds experienced net redemptions. A number of local managers plan to launch passive QDII products in the coming months. Guotai plans to launch a fund linked to the Nasdaq 100 Index and China Southern, following the ending of its sub-advisory relationship with BNY Mellon Asset Management will soon launch a fund tracking the S&P 500 Index. Grant Bailey, regional general manager of ING Investment Management, Asia Pacific, says it is “definitely a challenge” to win active sub-advisory mandates under current market conditions, but he does not think passive products – domestic or QDII – will dominate the Chinese market forever. “We believe that global diversification among different asset classes, different investment styles, and different markets would be of benefit to Chinese investors eventually.” He points out that on closer inspection, existing portfolios mainly offer exposure to Chinese companies listed offshore or foreign companies essentially playing the Chinese growth story. He contends that these QDII funds’ overseas investment characteristics are far from convincing. “On the contrary,” he adds, “QDII products linked to global indices would provide a much more genuine approach, actually investing in foreign economies. Thus, if launched, the new products should be regarded as a milestone improvement.” A July report from Z-Ben revealed that QDII funds made a strong comeback in the second quarter, posting an average return of 31.17 per cent. And QDII funds were shown to have collectively outperformed their domestic counterparts by more than 1000 basis points. Leading the way was Sino-foreign JV fund manager, Fortis Haitong, with a 43.71 per cent gain in its Enhanced China Offshore Fund. Launched in May 2008 and benchmarked to the MSCI China Index, the fund invests mainly in Hong Kong-listed companies with a small percentage invested in Nasdaq-listed Chinese new energy and internet stocks. Chen Hong, deputy general manager of Fortis Haitong, attributes the strong performance of the fund this year to its high equity weighting (71 per cent), correct sector allocation and stock-picking. “Back in the third quarter of 2008, during the financial crisis, we took advantage of the initial portfolio construction period to hold over 50 per cent cash,” he reveals. “Towards the end of 2008 and especially in the first half of 2009 when we were getting more confident in the economic recovery in China, we added aggressively to our equity weighting, which helped the fund catch up with the strong market rally.” Alas in Q3, Fortis Haitong lost half its QDII fund assets, as the five biggest QDII funds suffered net redemptions of almost 4 per cent despite posting stronger performance than their domestic passive counterparts who enjoyed net inflows. Mr Hong believes it will take some time for China’s asset managers to develop internal research and investment capabilities in the international market, especially for actively-managed products, creating opportunities for foreign asset managers to win sub-advisory mandates. The Bank of Communications Schroders Global Value Fund, holing $64m, was the second-best performing QDII fund in the first half of 2009 with a 35 per cent gain, up from -2.8 per cent at the end of last year. Lester Gray, CEO, Asia Pacific, at Schroders in Singapore says the fund was “very conservatively-positioned” until March when equity exposure was increased. He believes the opportunities for foreign fund managers will reduce over time due to a “possible move” to more passive QDII products and local asset management companies building their own offshore investment capabilities first in Hong Kong and ultimately further afield. He also thinks QDII will remain niche products relative to local mutual funds. Min Tha Gyaw, a spokesman for Z-Ben, says not all QDII funds planned are passive, and Chinese fund management companies could simply switch to launching something active if they find that passive funds are no longer popular. “Index funds are just one stage of the QDII program’s development, and those that are selling their active-style sub-advisory services may have to be more patient and work a little harder to make their case – it is by no means an end of opportunities. Over the long-run, well-managed Chinese fund managers will not bet on just one asset class for AUM growth/retentions and, therefore, they will try to offer at least a few different type of funds.” A sub-advisory relationship with fund managers in China is but one opportunity presented by the QDII scheme. Asset managers based outside of China are allowed to provide mutual funds to bank distributors in China for sale under their QDII licence. They can also pitch for sub-advisory QDII mandates from Chinese insurance companies.

Chen Hong, Fortis Haitong