The market share of Sino-foreign joint venture investment firms will neither rise nor fall over the next two years but remain at between 35 per cent and 45 per cent of total industry assets under management.
According to Peter Alexander, head of Shanghai-based consultants, Z-Ben Advisors, investors are allocating their capital to products that can deliver strong absolute returns, regardless of whether the provider is a domestic or Sino-foreign mutual fund manager. He notes that a number of smaller domestic managers have been able to exploit a strong track record to attract ad retain assets.
Taking a more optimistic outlook is Andrew Tong, president of SYWG BNP Paribas Asset Management, who maintains that the market share of Sino-foreign firms will grow, especially as more local asset managers are acquired by international investment houses or created as a result of consolidation. Furthermore, he believes the investment philosophy and process applied by joint venture fund management companies will gain greater acceptance by local investors through the passage of time and education.
 | Also upbeat about business growth prospects is Stewart Edgar, MD and head of Asia at Fortis Investments. He says the “slow but sure” diversification to foreign asset classes, facilitated by the Qualified Domestic Institutional Investor scheme, will favour joint venture fund management operations, through their foreign partners which have “a built-in expertise advantage”. |
According to David Lui, CEO of Bank of Communications Schroder Fund Management Company, whether or not the fortunes of Sino-foreign firms rise or fall will depend on four key factors, namely investment performance, brand name, the ability to innovate and distribution power.
“If Sino-foreign joint venture firms have a brand name recognised by the market and a reasonable upper-quartile performance which is consistent and can win distribution support from the banks, then I think they will be successful,” he says.
In striving to grow, the main challenge, adds Mr Lui, is achieving full co-operation between the two joint venture partners. While the closeness of cooperation varies from company to company, he says there have been reports of tensions between joint venture partners.
“But there are bound to be differences. How these differences are reconciled is the most important factor. A joint venture partnership cannot work well if there are strong differences all the time.”
Nature of cooperation
He spells out the nature of the cooperation that should be expected. The local joint venture partner should be able to offer strong sales and marketing support, while the foreign partner should contribute good risk management processes, research capability and investment methodologies to ensure consistent investment performance.
Chris Ruffle, director, MC China Limited at Martin Currie Investment Management, which manages $3bn (€2.23bn) of Greater China mandates ($1.5bn excluding Hong Kong and Taiwan), maintains that the foreign partners to a joint venture operation are in “an uncomfortable position” due to the maximum 49 per cent stake they are allowed to hold with state-owned partners.
He claims: “I have met several foreigners working for joint ventures crying into their beer over the mismatch between the ambitions of foreign and local partners. Staff turnover at joint ventures, where it is difficult to reward the best talent with equity, is high.”
Mr Ruffle adds that investment in China tends to be very short-term, which is “a headache” for the managers of open-ended funds. Local insurance companies have been big buyers of mutual funds in the past, but this is endangered as they are allowed to increase direct investments in equity markets or set up their own fund management companies. Similarly, many fund managers have depended for distribution upon state-owned enterprise (SOE) banks, which are also now setting up their own fund management companies.
“Also, there is a large informal private sector fund management sector (simu jiji) which has drawn off much talent. There are now official attempts to regularise this sector, which will increase competition.”
Another important success factor is investor education, especially in a young industry where many people still do not understand the inherent risks.
“2006 was an exceptional year in terms of market growth and a lot of investors think that sharp capital gains can be realised all the time. We have to teach them to be realistic in their expectations,” says Mr Lui.
Whatever future growth prospects, a report by management consultants, McKinsey reveals that two-thirds of Sino-foreign asset managers in China today have yet to reach a break-even point, estimated at around $700m to $800m of assets under management.
However, the ability to hit this threshold is dependent to a certain extent on the composition of a firm’s product portfolio, says Z-Ben’s Mr Alexander.
“Firms with a higher concentration of assets in money market funds, which generate fees of 33 basis points will need more assets to break even compared to a manager that has most of the assets in an equity or balanced product which earns 150 basis points in fees. The issue can also become quite challenging to address if certain firms are able to issue a new product and substantially boost their assets under management, which did in fact take place last year.”
Mr Lui of Bank of Communications Schroder contends that all fund management companies in China should have been “more than able to break even” last year on the back of a 130 per cent rise in the Chinese A-share market (Shanghai-Shenzhen 300 Index). For those firms which failed to break-even, it was because of the back-end or trail fees that they paid up-front to distributors.
“Companies have to take account of this back-end fee in their P&L account. I do not think that McKinsey considered the impact of this back-end fee in their research because they would have no way of telling.”
When it comes to achieving break-even on operations, Z-Ben’s Mr Alexander says all fund managers need to address the challenges of paying a trail to the distributing banks and how best to retain assets post-launch. Each of these elements though can be mitigated as long as a fund manager can deliver strong returns. Doing so will then pressure banks to reduce the trail needed to be paid while at the same time enticing clients to both purchase more shares in the product while at the same time refrain from selling preexisting shares.
“Additionally, keeping compensation under control might also be needed these days. Demand for portfolio managers is quite high with salaries now on par with Hong Kong,” he adds
Of the 20 Sino-foreign asset managers that were in full operation last year, Z-Ben Advisors estimates that 12 were profitable and eight were not. This conclusion was arrived at by comparing the average assets under management for all firms during 2006 and determining which had more than $750m on average during the year.
“We would even go so far as to say that 2006 was perhaps the best year for Sino-foreign managers with a number of these firms reaching profitability for the first time last year,” says Mr Alexander.
Market resurgence
He singles out GTJA Allianz, Everbright Pramerica and AIG-Huatai as Sino-foreign firms which are finding the going tough at present.
“GTJA Allianz’s largest product encountered stiff selling pressure during 2006. Everbright Pramerica has yet to gain any real traction in terms of gathering assets. That said, during the first quarter of this year, we noticed a market resurgence in the firm’s short-term performance track record which could assist in gathering assets in the future.”
Joseph Ngai, associate principal in McKinsey’s Hong Kong office and co-author of the report, remarks: “Asset managers should focus less on short-term performance and assets under management rankings and devote more attention to building a sustainable franchise, which will require significant investments in developing distribution channels, educating customers and grooming talent.”
The potential prize for those players who get it right is huge. McKinsey predicts that Chinese domestic mutual fund assets will rise from $110bn at the end of last year to $890bn in 2016, a compound annual growth rate of 23 per cent. When pension funds are added, the total pot could grow from $156bn today to over $1400bn over the next 10 years.
In bidding to boost profitability, Mr Tong of SYWG BNP Paribas says that fund managers are constrained by a lack of investment instruments, liquidity and long-term investors.
“The securities regulator has also imposed entry requirements on new activities which, in my view, may be too stringent. The rules that govern the advertising of fund sales also lack flexibility.”
But the real issue, contends Z-Ben’s Mr Alexander, is not constraints put in place by the markets or the regulator. Rather constraints are in place based on end-demand.
“Investors are only keen on buying into the products that best meet their current needs. If share prices are rising then demand will be squarely on equity-oriented products. If share prices are weak, like in 2005, then demand will be centered entirely on low risk alternatives such as money market funds. The CSRC [securities regulator] does appear to now favour fixed income products, but only one firm has decided to take advantage; Galaxy Fund Management. After an entire month raising funds the Galaxy Yinxin Bond Fund, the first pure fixed income product issued since August 2006, ended with Rmb2.5bn (€24m) in assets and well below the Rmb9bn raised in a matter of days for an equity product.”
FORTIS DIVERSIFYING ASSETS TO ADD SENSE OF STABILITY
Shanghai-based Fortis Haitong Investment Management, which has over €3bn of assets under management, was adversely affected in 2006 by a mass exodus from its flagship fund – the Fortis Haitong Income and Growth Fund. However, lost assets were recovered as the Fortis Haitong Equity Fund saw good inflows and the firm increased assets under management by 42 per cent in fiscal 2006.
Stewart Edgar, MD and head of Asia at Fortis Investments says the strategy from the beginning has been to diversify assets under management into three main areas – domestic (Chinese A-share) mutual funds; funds for non-People’s Republic of China (PRC) clients (for example, Qualified Foreign Institutional Investor scheme); enterprise annuity (Chinese corporate pension scheme) clients.
This mix, he explains, lends stability to the business and makes it less prone to the effects of fluctuations in any one customer base. In addition to Fortis Haitong’s domestic Chinese mutual fund exposure, the firm advises on over €1bn in PRC-listed assets under management for foreign clients.
Mr Edgar, who is based in Brussels but spends most of his time in Asia, says: “Over 2006, Fortis Haitong added an Absolute Return Fund and a Growth and Income Fund to the domestic fund range and saw good inflow via a secondary offering of its equity fund. A B-share fund was launched for non-domestic clients. In January 2007, a successful secondary offering of the Growth and Value Fund further boosted assets under management significantly. The firm also received its first enterprise annuity clients in last year, an area which we believe to be key for future growth.”
He says Fortis Haitong, which was established in 2003 (Fortis Investments holds a 49 per cent stake in the joint venture) has been profitable since 2004 on an annual and cumulative basis and claims that its EBITDA margin is higher than the Fortis Investments group average.
“We have always been focused on profitable growth with less emphasis on simple AUM accumulation.”
He believes the main challenges facing Sino-foreign firms include dealing with the scale of activities in China.
“At present Fortis Haitong has more than 600,000 unit holders in its funds and as this figure rises, servicing clients will pose particular challenges for managers and distributors. The “war for talent” is also an increasing issue due to the rapid development of the financial sector as a whole.
To succeed, he says, companies will need talented staff, strong positive cash flow, competitive investment performance, product development skills, competitive remuneration systems, IT investment, strong distribution links and a diversified customer base.
