Chinese investment houses running publicly-traded mutual funds are facing a growing competitive threat from privately-managed funds, according to a report by Shanghai-based consultants, Z-Ben Advisors.
While private funds have been operating in China for a long time in one form or another, their proliferation now is being fuelled by the brain drain affecting the asset management industry. Z-Ben has found that, far from retiring into the sunset, a number of former chief investment officers and star portfolio managers have established private investment advisory firms which will end up directly competing against their former employers.
The rivalry between large mutual fund groups and private advisors is already unfolding with “battle lines being drawn” over the recruitment and retention of scarce investment talent. The report notes that top portfolio managers moving on to the private domain will sooner or later persuade talented analysts and traders to follow them. So what is the attraction for fund professionals who are already handsomely remunerated? Z-Ben points to the greater investment flexibility and minimal regulatory oversight at private funds.
As a result, says the report, “investment strategies are only limited……by the portfolio manager’s imagination and the shareholder’s appetite for risk.” By contrast, mutual fund strategies must conform to layers of regulation and more stringent compliance procedures.
The investment professionals which have set up new private fund shops have done so in conjunction with a trust company (see table). This allows them to circumvent regulations prohibiting independent investment advisors from directly raising capital, an activity that trust companies have historically focused on. The role of the investment advisor is limited to making investment recommendations on a portfolio of pooled assets.
“It is the first time that we have seen former professionals from the funds industry create their own legal structure for managing private funds,” says Peter Alexander of Z-Ben.
The big mutual fund houses, which managed assets totaling more than RMB3200bn (€297bn) at the end of last year, are unlikely to be suffering sleepless nights over these new upstarts for the foreseeable future. To date, only four private fund shops have been set up in cooperation with a trust company, of which three are fully operational. The first private trust product was only issued three months ago. Also, the China Banking Regulatory Commission – the agency which oversees trust companies – has restricted any product marketed by a private investment advisory firm from issuing more than 200 shares. But notes the report, the rules do not explicitly state how many individual products or individual tranches a trust company can issue and this loophole is being actively exploited.
Even, by the most aggressive estimates, all four advisory firms operating at full capacity would raise no more than RMB12bn – a drop in the ocean compared with the size of the mutual fund industry. Z-Ben says that private fund shops will only pose an immediate competitive threat if the performance of mutual funds deteriorates rapidly.
In terms of investment style, the private funds which have been launched to date resemble “a long-short hedge fund without the short position” The products are not permitted to buy shares classed as ‘Special Treatment’, meaning listed companies with a reported net loss for two consecutive years. In addition, a number of the private funds have committed not to allocate more than 20 per cent of a fund’s assets to a single stock.
Although not explicitly stated in the product prospectuses, Z-Ben says it is understood that private funds will levy a performance fee amounting to 20 per cent of any gains above a stated hurdle rate.
The report also finds that while banks remain the dominant fund distribution channel in China, their position is coming under attack from asset management companies which are setting up electronic fund distribution centres, which enable investors to buy products online and thereby avail of a discount on the front-end fee. At the same time, a central payment processing system called China Pay, which was created by a consortium of all the Chinese banks is, according to Z-Ben’s Mr Alexander, being transformed into a big investment fund supermarket. A number of independent fund distributers are also trying to come online.
China’s four big banks have responded by announcing that they are going to create their own funds supermarket in-house. “Already an investor can open an account at ICBC and choose from three quarters of every available mutual fund. So we are seeing a shift towards electronic fund distribution and an investment populace that is far younger and more adept,” says Mr Alexander.
