The repercussions of the recent dramatic fall in China’s A-share market for both domestic and joint venture fund management companies should be limited, according to Peter Alexander, head of Shanghai-based consultants, Z-Ben Advisors.
He anticipates further stock market gains in the coming weeks and months, accompanied however by continued volatility.
“While the Shanghai market did drop by its largest percentage amount in 10 years [9 per cent], it has also traded up or down by 2 per cent or more on 19 of the first 35 trading days this year. We expect more of the same,” he says.
Mr Alexander believes the current stock market environment carries risks such as the volatility in the flow of funds over the past two months. Billions of renminbi are being injected into and redeemed out of many [mutual fund] products, so making the investment process “quite challenging” for all portfolio managers, especially given that a high cash allocation is needed to meet potential redemptions. This in turn acts as a drag on performance during times when the markets are rising.
Demand for equity funds remains strong, he notes. On the day before the correction, the first equity product of the year – the CCB-Principal Optimised Balanced Fund - was launched by a joint venture fund management company. It raised RMB10bn (€98.5m) in a matter of hours.
“Also note”, he adds, “that while not formally confirmed, the CSRC [China’s securities regulator] has placed a tacit cap on new products of RMB10bn meaning that CCB-Principal could have easily raised more assets if permitted.”
Andrew Tong, president of SYWG BNP Paribas Asset Management in Shanghai, says that, despite the market drop, his approach remains equity-driven. His firm will focus on the continued sale of existing funds while launching new products such as sector-rotation funds.
Although the market is volatile, he reckons that numerous asset management companies could raise tens of billions in new inflows for old and new funds alike. This, he says, indicates that confidence in the market remains strong.
He is still confident of a sustainable bull market in the mid- to long-term, maintaining the correction was largely due to the “somewhat stretched” valuation of the broad market in the near term.
Flooding with liquidity
That said, he concurs with Z-Ben’s Peter Alexander that the index might trade within 200 index points for a period of time.
On the macro-economic front, Mr Tong says trade surpluses and renminbi appreciation will continue to flood the market with liquidity. Trade surpluses are expected to exceed $200bn this year, raising the foreign exchange reserve to between $1200bn and $1300bn. These factors will dictate the investment approach of more than RMB32,000bn of bank deposits.
Further market falls might increase the appeal of money market funds over bonds, due to the short duration of such investments.
“However, funds in money market funds are parked for volatility trading and the volume of such products may not return to its peak in 2005,” says Mr Tong.
Mandy Wang, CEO of Shanghai-based joint venture fund management company, China International Fund Management, says that if the market displays continued volatility, the CSRC will encourage asset managers to launch new products to allow more capital flow into the market.
But despite the significant increase in the A-share market in 2006, her firm’s long-term business strategy is the development of more “defensive” fund products.
Usually in a falling market, fixed income funds and balanced funds will outperform equity funds.
Of the total 108 mutual funds on the Chinese market today (84 funds have been issued by the 22 registered joint venture fund management companies and another 24 funds by two foreign invested managers), 55 can be classed as ‘defensive’, that is, bond, balanced, money market and guaranteed funds.
The move out of short-term bond funds and money market funds, which started in the second quarter of 2006, has benefited fund managers in terms of profitability, according to Z-Ben Advisors. At the end of 2005,
nearly half of all assets were invested into money market funds that generated only 33 basis points in management fees. Now most assets reside in equity or balanced funds which generate management fees of 150 basis points.
“Furthermore”, says Mr Alexander, “the rise of a secondary market, fuelled by the CSRC placing a moratorium on new product approvals, has meant that fund managers are finally able to leverage the scale of their operations. That in turn should mean that profit margins will expand for most fund houses and significantly so for a number of firms.”
Joint venture fund management companies have seized a considerable share of the investment market from their domestic counterparts, with combined assets under management rising from RMB121bn at the end of 2005 to RMB335bn – almost 40 per cent of industry assets – at the end of last year. Harvest Fund Management (19.5 per cent owned by Deutsche Asset Management) led the way, predominantly on the strength of a RMB41bn product launch (achieved officially in a single day). This propelled the firm to a ranking of first among all managers, domestic and Sino-foreign alike.
CHINESE REGULATOR SOFTENS OUTWARD INVESTMENT STANCE AS QDII DEMAND WILTS
China’s Qualified Domestic Institutional Investor (QDII) has been slow to take off. Last September, Lehman Brothers and Hua An Fund Management teamed up to launch a new foreign currency-denominated fund which allows Chinese investors to invest in foreign assets for the first time. Hua An was China’s first asset manager to be granted QDII status.
The driver of QDII is China’s rapidly growing foreign reserves. The central government wants to release some of this money to offset the growth of the inflow. But with the domestic stockmarket performing so poorly in 2005, the regulator was against QDII for fear that if the door was opened, money would flood out of the country and go to Europe and the US.
But with the Chinese A-share market having risen by 121 per cent (Shanghai-Shenzhen 300 index) since the end of 2005, the regulator has softened its stance on outward investment.
Lehman Brothers and Hua An were awarded a QDII allocation of $500m (€381.6m). Another $500m allocation was expected to be approved by the regulator before year-end but that has not yet happened. Not surprisingly, the resurgence in the A-share market has been blamed for the general lack of interest in QDII.
Peter Alexander, head of Shanghai-based consultants, Z-Ben Advisors, says: “The argument that few would be interested in any offshore, foreign currency denominated offering given the expectation of a continued appreciation in the Renminbi is obviously valid, but not the rationale behind a lack in demand. In addition, we also believe that the concept of QDII hasn’t been best communicated to investors and with that, actual demand has diminished.”
He maintains there are benefits beyond just yield to consider with risk reduction through diversification most notable which should be communicated to the investing public and especially to institutional investors such as insurance companies.
Z-Ben expects QDII to be a “slow burn” to be quite successful over the next several years. Mr Alexander predicts that by the end of the decade, QDII will play an integral part in China’s investment management industry and he advises foreign firms to begin developing business today and not wait until the scheme has become mainstream.
To date, a total of $19.07bn in QDII quotas has been issued – $13.4bn to 15 commercial banks, $500m issued to one fund manager [HuaAn Fund Management] and another $5.17bn provided to 15 Chinese insurance companies. While this is nearly double the amount issued in the Qualified Foreign Institutional Investor (QFII) scheme, only a fraction of the issued QDII quota has been used so far.
A second fund manager QDII product was expected to be issued before the end of last year. That did not, however, take place.
According to Mr Alexander, this was due to the lack of end demand for the initial HuaAn/Lehman product which only raised $200m.
He says:“We suspect that the regulators wanted to ensure that the second product (which is expected to be issued by Southern Fund Management) would end stronger before moving forward. We are looking for a second launch to take place at some point in the early second quarter with the first joint venture fund manager approved to follow suit soon there after.”
Thierry Mequillet, CEO of Crédit Agricole Asset Management in Hong Kong, says his firm has been talking to a number of the commercial banks which have been granted QDII quota. He adds that the company’s CA Funds Greater China was selected by Bank of China for its second QDII product which was launched in February 2007.
