The Chinese government should remove the restriction of the Qualified Foreign Institutional Investor (QFII) quota and allow a free flow of offshore money into the country in order to boost capital markets.
The call comes from the head of a Shenzhen-based joint venture fund management operation who adds that unless the authorities work harder to improve corporate governance at Chinese-listed companies, securities houses and investment firms, potential investors will continue to stay away.
While the total QFII quota is expected to rise to $6bn by the end of 2005, the amount really only represents a shoring up of weak capital markets which still await increased interest from local retail and institutional investors.
Chris Ryan, chief investment officer of ING Investment Management Asia Pacific, maintains that the involvement of China’s big state banks will drive mutual fund discovery as between them they have hundreds of millions of customers.
He says: “While the entry of the banks could be looked upon as a competitive threat, it is a huge positive for the funds industry. It is up to the other fund managers to have the right product strategy, branding and service quality to negotiate distribution deals with these banks.”
Pension fund developments in the form of China’s new corporate pension schemes or enterprise annuities will also drive mutual fund discovery, according to Mr Ryan. ING, through its joint venture fund management operation, China Merchants, was one of three European financial groups to receive a licence this year to manage these new voluntary schemes. The firm is busy promoting its investment capability to Chinese corporates.
Mr Ryan disputes the claim that the IPO mentality in China makes it difficult to sell old funds.
“We launched a new equity fund at the end of October which was our first new offering in a year. But our assets have still tripled in that period of time. So it is still possible to sell existing funds by providing good service and making you are dealing with the right type of distributor,” he says.
Given their huge distribution networks and captive client bases, the four big state banks – Bank of China, Industrial and Commercial Bank of China (ICBC), Bank of Communications and China Construction Bank – are the perfect product seller for every fund manager. It is just a matter of getting in the door.
 Lefranc: big bank distribution is expensive | But according to Denis Lefranc, deputy general manager of Fortune SGAM Fund Management in Shanghai, it is difficult to gain distribution through these large state banks without first giving them a custody mandate, even though there is no legal obligation to do so. |
The custody fees, he adds, at 25 basis points for an equity fund and 20 basis points for both a bond fund and a money market fund are also high compared with the level of fees charged in Europe and the US.
“That is expensive when you consider that we can only buy local securities,” he says.
Despite growing competition from the banks and the impending entry of insurance companies into the funds market, Mr Lefranc believes the industry will move more in the direction of open architecture.
“All of the big banks have told us that they do not wish to work only with their own fund management company,” he claims.
However, Jack Lin, chief executive officer of Franklin Templeton Sealand Fund Management in Shanghai, says that each of the banks and insurance companies will reserve a third or more of their capacity for their own investment products.
Clayton Coplestone, sales director at Credit Suisse Asset Management (CSAM) in Hong Kong, adds that even when the banks agree to distribute third-party funds, they will always give priority to promoting proprietary product.
He observes that while smaller fund managers have forged deep relationships with the banks, sales figures show that these relationships are not delivering results.
He believes that large fund managers with strong brand names will stand a better chance of distribution success.
Kerry Ching, chief executive officer of Invesco Asia in Hong Kong, maintains that over time only those fund managers who can deliver consistent performance will be able to partner with the significant distributors.
The boss of another of China’s 20 joint venture fund management companies paints a bleaker picture for smaller investment houses, claiming they cannot get a commitment from the big banks to distribute new funds. He adds that firms gathering between RMB400m-1bn of assets will not make a profit. The break-even level, he says, for equity funds is RMB3-3.5bn.
Mr Coplestone of CSAM, which formed a joint venture fund management company with ICBC in June 2005, says the cost of basing an investment business in Shanghai was high, due largely to rising salaries. The absence of knowledgeable and experienced investment personnel in the city is a factor driving up company pay levels.
Firm distribution links with the big banks will become even more vital to survival and profitability in the future, as research by Cerulli Associates reveals that by 2009, these institutions will enjoy an 89 per cent share of the mutual funds market in China.
CSAM recently demonstrated the advantage of joining forces with a large bank when its first equity fund pulled in RMB4.3bn. The joint venture company will follow this in early 2006 with the launch of a short-duration bond fund which Mr Coplestone expects will attract far more assets than the equity IPO.
Lauren Yao, head of marketing at Shanghai-based Fortis Haitong Investment Management, says the three banks which have started fund management operations – Bank of China, Bank of Communications and ICBC – could each collect five times more in a fund IPO than the average $80m pulled in by non-bank fund managers.
She says research by Fortis Haitong shows that the 10 biggest investment houses in the funds market controlled 70 per cent of total assets under management at the end of September 2005. She adds that a rumour has been circulating for a year that post offices might become distribution outlets for mutual funds.
If small fund managers cannot match the asset-gathering power of the big banks, they can make up for their lack of distribution muscle with good, consistent performance and client support.
There is a consensus among fund managers that banking distribution networks will confer only a short- to medium-term advantage. Long-term success will depend on fund performance.
But Mr Lin of Franklin Templeton Sealand says that managers face a dilemma. Since investors rush to redeem when returns are high and tend to stay in when funds are down, asset managers might question the merit of striving to achieve top performance.
Regulatory restrictions on product innovation are another industry bugbear. At present, the China Securities Regulatory Commission (CSRC) will permit only equity funds, fixed income funds, money market vehicles and exchange-traded funds (ETFs).
Denis Lefranc of Fortune SGAM says his firm is interested in launching ETFs but is currently deterred from doing so by the plethora of different indices in the market.
He says: “No index yet represents the two stock exchanges, Shanghai and Shenzhen. The issue for us is to work with a provider which could really define a representative market index.”
While State Street Global Advisors does not have a joint venture fund management operation in China, in February 2005 it advised Beijing-based China Asset Management on the launch of the first ETF in the market, the China 50 ETF, which tracks the performance of the SSE (Shanghai Stock Exchange) 50 Index. The ETF has approximately $900m in assets.
With the exception of money market funds, both institutional and retail investors are charged the same level of management fees. However, a draft CSRC regulation could allow the fund manager to offer discretionary investment mandates at some point in the future.
Another development the funds industry is patiently awaiting is the introduction of the Qualified Domestic Institutional Investor scheme (QDII). Designed to allow Chinese-based institutions to invest in non-domestic assets, QDII is being driven by the central government’s desire to release some of China’s rapidly-growing foreign currency reserves to offset the growth of the inflow. Some commentators contend that on account of the sluggish stock market, the CSRC is lobbying against QDII, fearful that if the door is opened, money will simply flood out of China and into Europe and the US.
While the fund management industry is excited by the business opportunities presented by QDII, practitioners agree that the scheme is unlikely to be introduced for at least three to five years.
The maximum stake a foreign company can hold in a joint venture fund management operation is 49 per cent. According to Mr Lefranc of Fortune SGAM, this is a contentious issue for many fund managers who would like to have a majority stake.
Mr Lefranc does not believe the authorities will ever allow investment houses in China which are 100 per cent-owned by foreign fund managers.
“While the foreigner is bringing all the international experience in terms of risk management, compliance and investment process, the Chinese company is bringing his local stock market knowledge and distribution connections,” he says.
