China's fund-of-funds industry is set to play an increasingly important role in shaping the country's fledgling hedge fund sector, even as some question how effective a gatekeeper it can be at its own early stage of development.
The need for talented gatekeepers is clear. The ranks of China's private “hedge fund” firms — so-called even though only a fraction employ derivatives and futures contracts to hedge — more than doubled to 18,000 since 2013, when a regulatory framework for them was established.
That has left thousands of newly minted firms competing for the client assets they need to sustain themselves, while posing a challenge for institutional clients looking to separate the wheat from the chaff, said Yeh Chengsen, a partner with ZeeDao Holdings Co. Ltd., a Shanghai-based solutions provider for hedge funds and their institutional clients.
To help the best Chinese hedge funds grow, ZeeDao structured a hedge fund conference in Shanghai in mid-February as a “matchmaking exercise,” bringing 50 Chinese fund-of-funds firms together with more than 1,000 hedge funds, said Mr. Yeh, who serves as CEO of his group's own fund-of-funds operation, ZeeDao Hulian Investment Management Co. Ltd., launched recently with 50 million renminbi of partner money.
While there's no definitive data, market veterans agree fund-of-funds assets are growing quickly now as more asset managers, banks and insurers launch their own fund of funds businesses.
The China Fund of Funds Alliance, an industry association launched in March 2016, predicts combined assets for all fund of funds — including those that invest in private equity, publicly traded securities and real estate — will more than triple to 1 trillion renminbi ($145 billion) by the end of 2017 from RMB 300 billion at present, a spokeswoman for the association said.
Brian Ingram, president and general manager of Russell Investment Advisors (Shanghai) Co. Ltd., said it's unlikely that public security fund of funds account for more than 20% — or RMB 60 billion — of the China FOF Alliance total. But that pool could more than triple by the end of the year, as relatively strong growth allows it to claim a bigger chunk of a fast-growing pie, he said.
Hedge fund managers attending ZeeDao's conference said the message of growing funds-of-funds opportunities is one they've taken to heart.
Funds of funds' share in Shanghai Longture Capital Management Co.'s assets under management is growing, noted Meng Cheng, CEO of the Shanghai-based manager of quantitative hedge funds and commodity trading adviser strategies, in a recent interview.
“Thirty percent of our assets” of roughly RMB 2 billion are from institutional investors, via hedge fund-of-funds or manager-of-managers vehicles, up from 20% a year ago, said Mr. Meng. High-net-worth investors account for the bulk of remaining AUM.
Longture was established on April 30, 2015, after Mr. Meng's investment team, with a relatively long history - for China - of five years, broke away from Shanghai-based Milestone Capital Management.
Funds of funds are even more important for smaller or newer hedge fund firms looking to attract institutional capital, said Felix Du, a fund operations analyst with Beijing-based Redhorse Fund Management Co.
Redhorse, incorporated in 2015, launched its first hedge fund in July and currently manages RMB 50 million across three funds - half coming from the firm's employees and the other half from high-net-worth investors, said Mr. Du.
“This year, we're positioning ourselves to target institutional investors” via fund-of-funds strategies to “boost our AUM,” he said.
Still, with China's hedge fund-of-funds sector just getting off the ground, market veterans say it's hard to predict how soon those vehicles will be able to play a significant role in promoting the healthy development of the country's hedge fund industry.
Every financial firm and third-party distributor is setting up fund-of-funds operations now but few have the infrastructure needed to play an effective gatekeeper role, said William Weng, managing partner of Shanghai Co-Win Shengyun Asset Management Co., a Shanghai-based hedge fund firm.
While the need for diversification, following the market's recent volatility, has driven that push, there's been little appreciation of the scale and the operational capabilities needed to “analyse, track and monitor” the underlying manager universe or negotiate terms with them, he said.
Many funds of funds now have more capital and distribution muscle than investment capabilities, agreed Jeff Li, a veteran of Citco Fund Services (Shanghai), OpHedge Investment Services LLC and Goldman Sachs & Co.'s quantitative equity group who founded fund-of-funds firm Sycamore Investment Services (Shanghai) Ltd. in January 2016.
The industry remains more focused on developing investment processes than on selling investment products, said Mr. Ingram. Getting to the point where China's fragmented funds of funds can be effective gatekeepers will likely require some consolidation, preferably on the strength of attracting institutional third-party money - “an unproven proposition at this point,” he said.
Meanwhile, some market watchers contend there's little evidence fund-of-funds assets are any more patient than the high-net-worth and retail investors who continue to dominate Chinese financial markets.
Mr. Meng said Longture hasn't found that to be the case. The firm's fund-of-funds clients - composed of insurance, bank and some high-net-worth accounts - have been relatively “patient ... long-term” investors, he said.
But he conceded that pension and endowment money remains a very small part of the market in China.
Some pension fund executives predict that is set to change.
Speaking at the ZeeDao conference, Feng Liying, president of Beijing-based CCB Pension Management Co. Ltd., told attendees that pension fund money should be on their radar screens in coming years. CCB Pension Management, a unit of the China Construction Bank, has licenses to manage a full range of pension money in China, and RMB 25 billion in pension assets under management.
Big public funds in China oversee roughly 80% of the country's undersized pool of retirement savings, with employer-sponsored pension plans and private retirement savings accounting for the rest, in stark contrast with the U.S., where corporate and individual savings account for the vast majority of retirement assets, said Ms. Feng.
China's corporate and private retirement pools will inevitably grow much faster in the future, offering up “a great opportunity for all of you,” she told the audience of hedge fund managers. “Pensions are going to be a new growth engine for the asset management industry,” she predicted.
Steve Zeng, a Shanghai-based spokesman for Noah Holdings Ltd., China's leading independent fund-of-funds provider with RMB 120 billion of mostly high-net-worth money under management, said his firm began targeting institutional investors as well last year. At the end of 2016, high-net-worth investors still accounted for more than 90% of the firm's AUM, of which roughly 50% was in private equity fund of funds and 7.5% in hedge fund of funds.
Sycamore's Mr. Li said his firm just launched its first multistrategy fund of funds, with RMB 300 million, after a year developing the company's systems, with a focus on its asset allocation system and refining its evaluation system and selection model for hedge funds.
While the fund-of-funds industry in the U.S. and other developed markets took 20 years to peak before declining, Mr. Li said China's industry could see a compressed timeline, possibly maturing within five years - a “very fast” boom-bust cycle. Even after it peaks, however, he predicted firms capable of offering a good value proposition will survive and continue to grow.
In an apparent vote of confidence for China's fund-of-funds industry, Sequoia Capital China, an affiliate of Menlo Park, Calif.-based private equity firm Sequoia Capital, in October bought a roughly 8% stake in Noah's fund-of-funds affiliate, Gopher Asset Management Co. Ltd., for RMB 348 million. Gopher Asset Management has RMB 120 billion under management, in private equity, real estate, fixed income and hedge funds. Neil Shen, managing partner of Sequoia Capital China, didn't return calls seeking comment.
This article originally appeared in the April 3, 2017 print issue as, "China fund-of-funds industry beginning to blossom".