Chinese managers facing growing pains

The teenage years can be tough, especially in a home environment where the rules are always changing.

China's fund management industry is a case in point.

Fifteen years after regulators issued the first fund management company license in China, and five years into a stubborn bear market for the country's A shares, the industry continues to struggle as artificially high risk-free rates of 5.5% to 6% effectively crush domestic investor interest in equities, said Xu Lin, special assistant to the CEO of Shanghai-based HFT Investment Management Co. Ltd.

That interest rate structure left fund management companies overseeing between 2 trillion and 3 trillion renminbi ($323 billion and $482 billion) in mutual fund assets over the six years through the end of 2013, according to data provided by Z-Ben Advisors, a Shanghai-based consultant on investment management business opportunities in China. (All dollar figures in this story are in U.S. dollars.)

By contrast, for that same period, data from the China Trustee Association, Beijing, show trust company assets jumped to 10.91 trillion from 1.22 trillion renminbi, according to Z-Ben's data.

With Shanghai's composite index down roughly two-thirds from its pre-crisis peak in October 2007 and, following a short-lived bounce in 2009, down again by roughly a third, the fund management industry “hasn't lived up to the expectations that many would have had for it,” said Nick Gardiner, a Hong Kong-based partner and managing director with Boston Consulting Group's investment management practice.

Even so, industry executives and analysts predict some of China's current crop of 90 fund management companies should have a good shot at leveraging competitive advantages at home to become significant regional or global players in the coming decade — something few Asia-based managers can boast.

Most of the industry's biggest players — including Beijing-based China Asset Management Co. Ltd., and Harvest Fund Management Co. Ltd.; Bosera Asset Management Co. Ltd. and China Southern Fund Management Co. Ltd., both of Shenzhen; and GF Fund Management Co. Ltd., Guangdong — have set that goal.

In an interview, Lambert Xu, head of business development with Bosera's Hong Kong-based subsidiary, Bosera Asset Management (International) Co. Ltd., said his institutionally focused parent company, with more than $32 billion in assets under management at the end of 2013, is aiming to manage $300 billion within five years and move into the ranks of the top 100 managers globally.

Bosera will consider acquisitions to attain the investment capabilities needed to help investors at home diversify overseas as they become increasingly sophisticated, said Mr. Xu.

While such ambitions are widely shared, industry veterans warn that China's fund management companies have a long way to go in reaching those goals.

“A lot has happened in China's local fund industry in the last decade, but competing at a regional or global level is a different ball game altogether,” said Felix Ng, a Singapore-based senior analyst with Cerulli Associates. Ten years might prove an ambitious timetable for making it into the big leagues, he said.

With fund management companies struggling to eke out profits from their core domestic mutual fund businesses, a number have set up Hong Kong subsidiaries in recent years and found it to be an extremely competitive environment, said Chen Ding, chairwoman of the Chinese Asset Management Association's Hong Kong branch, and CEO of CSOP Asset Management Ltd., Hong Kong, a joint venture between China Southern and Hong Kong-based OP Financial Investments Ltd.

Maybe one or two of the more than 20 subsidiaries of China-based fund management companies in Hong Kong are making a contribution to their parent company's bottom line, but even some of the biggest names have yet to turn the corner, said Chengsen Yeh, a Shanghai-based director with accounting heavyweight EY's money management business.

CSOP, with an industry-leading $6.6 billion in assets under management at the end of February, has enjoyed relative success building its overseas business from Hong Kong, but its product line still has a long way to go to match the scale and sophistication of the firm's foreign competitors there, Ms. Ding said.

A lack of product innovation is one challenge noted by many industry observers. “If you look at the industry, very few players differentiate themselves,” said Bonn Liu, a Hong Kong-based partner with accounting giant KPMG China, and practice leader for the firm's China securities and funds practice. “They all look the same — a "me-too' market,” he said.

A recent, dramatic exception has been Tianjin-based Tianhong Asset Management Co. Ltd.'s mid-2013 launch of a money market fund that allowed tens of millions of customers for Alipay, China's largest online payment company, to shift as little as one renminbi sitting idle in their accounts into the fund, with an annual yield of 5% or more. In the space of nine months, the fund has gobbled up more than 400 billion renminbi, transforming Tianhong from an industry also-ran to top dog, in AUM terms. (See accompanying story.)

Tianhong's triumph aside, the charge that China's managers all serve up the same dishes has been more or less true because investment restrictions in China — prohibiting things such as hedging or the use of leverage — left all managers confined to managing straight equity, fixed-income or money market funds, Bosera's Mr. Xu said. But now things are changing, he said.

Last year, for example, regulators gave their blessing to the introduction of futures contracts, which portfolio managers could use for hedging purposes. HFT's Mr. Xu said that reform was the basis for his firm introducing strategies with hedge fund structures recently.

More sophisticated products could come in handy as China's continued market opening lures more offshore institutional money to the country.

On March 12, in recognition of that progress, MSCI Inc. announced a “road map” for the gradual inclusion of China's A shares in its widely used emerging markets equity benchmark index. MSCI proposed an initial weighting of 60 basis points in the index starting in May 2015, representing 5% of the A-shares market's free-float capitalization.

That toe in the water reflects the fact that offshore investors looking to invest in China and Chinese investors hoping to allocate money overseas can still only do so using quotas doled out by Chinese regulators, namely:

• the qualified foreign institutional investor program launched in 2003, with $52.3 billion in quotas extended to 237 securities houses, asset management firms and institutional investors as of late February;
• the qualified domestic institutional investor program launched in 2007, with $86.5 billion in quotas awarded to 119 locally based banks, trust companies, insurers and fund management companies; and
• the renminbi qualified foreign institutional investor program, launched in late 2011, with 180 billion renminbi in quotas to 59 Hong Kong-based brokers, insurance companies and asset management firms.

If capital flows were unconstrained, A shares would account now for just more than 10% of MSCI's Emerging Markets index.

The Beijing-based Asset Management Association of China's data for the institutional assets of fund management companies only go back two years - with 1.22 trillion renminbi at the end of 2013, up sharply from 760 billion renminbi at the close of 2012.

For Rongtong Fund Management Co. Ltd., institutional business has become more important, growing from nothing three years ago to 10 billion renminbi of Rongtong's 55 billion renminbi at the end of 2013, said Allen Yan, the Shenzhen-based firm's deputy CEO.

GF Fund Management, China's sixth largest fund management company with 130 billion renminbi as of Dec. 31, is building its capabilities under China's QFII and RQFII programs, looking to hire “more hands to develop our institutional business in Korea, Taiwan and Singapore,” said Nathan Lin, the general manager of Hong Kong-based GF International Investment Management Ltd.

Likewise, Terrance Hui, the CEO of Shenzhen-based Invesco Great Wall Fund Management Co. Ltd., said QFII and RQFII will become “a higher priority focus for us this year.” While IGW's focus on A shares has left some firms better positioned to compete for onshore institutional business — where insurers' allocations to equities, for example, are capped around 25% — any move by MSCI to include A shares in its equity indexes will play to IGW's strengths, he said.

Mr. Lin said at this point he doesn't see GF as either a China boutique or a global player. “In five years' time, we should be a regional manager — one of the best,” he said. The firm's Hong Kong office, launched in 2010, should be followed by a sales and marketing office in London in the next few years, he added.

CSOP's Ms. Ding said she's optimistic that, as China continues to open its markets, her firm, and other China-based fund management companies in Hong Kong, will be able to leverage their strengths investing at home to take advantage of an inevitable jump in cross-border investment opportunities — both global investors looking to allocate more to China and Chinese investors as they wake up to the need for diversification.

Bosera's Mr. Xu said for now, inbound investment opportunities in China are more immediate, but helping Chinese investors diversify abroad — through the QDII program — will eventually be an equally interesting opportunity.

That program has sputtered in recent years, as the wave of interest that accompanied its launch in July 2006 was quickly doused by the global financial crisis — a “good time for marketing but a very bad time to come in,” noted Bosera's Mr. Xu. But that was six years ago and the outperformance recently of foreign financial markets hasn't gone unnoticed, he said.

Some market watchers insist a “once burned, twice shy” mentality still prevails in China with regard to investing overseas, but Boston Consulting Group's Mr. Gardiner noted signs of “a lot of interest now for QDII investments.” That interest could find the almost 50 foreign joint venture partners called upon to help their local partners invest money overseas, he said.

For the next few years, QDII will be “hot, every hot,” Bosera's Mr. Xu predicted. For now, Bosera, owned 100% by Chinese stakeholders, needs to identify a foreign partner to help investors in China allocate money abroad, but longer term the company will look to “build our product line for outbound money” — starting with establishing representative offices in London and New York in the next three to five years.

CSOP — which has taken advantage of the RQFII program China launched at the end of 2011 to offer A-shares-focused exchange-traded funds in New York and London — has had some success in building its brand name overseas, recognition that should have the firm well placed to benefit as cross-border flows jump, Ms. Ding predicted.

If the future can nonetheless be judged bright for the fund management industry, the present remains challenging, with industry analysts saying the smallest 40 to 50 firms are most likely losing money.

“Consolidation is probably inevitable, and everyone needs to think about what (they're) going to do for the next few years to win this game,” said Ying Tan, a senior manager researcher with Mercer in Hong Kong.