China money managers feel brain drain

China's fund management companies are struggling to retain investment talent just as a growing cadre of offshore asset owners could be mulling first-time allocations to the country's capital markets.

Fund management companies saw “tremendous turnover” in the past year, especially in the second half as China's domestic A-shares market surged, said Charles Salvador, director, investment solutions with Z-Ben Advisors, a Shanghai-based consultancy on business opportunities in China's financial industry.

More than 150 senior investment professionals left fund management companies in 2014, noted Ying Tan, a Hong Kong-based principal with Mercer who researches asset management firms in the Greater China region. And while those professionals moved for a variety of reasons, many are likely to join private boutiques or set up their own, encouraged by the recent “bull run” by A shares, she said.

In China, “fund management companies” is a specific term, referring to the roughly 100 firms set up under the 1998 law establishing the country's mutual fund industry.

The relatively gradual increase in recent years in the ranks of those fund management companies, licensed by the China Securities Regulatory Commission, stands in contrast to the rapid growth of private “hedge fund” firms — which, despite that term, are mostly long-only managers operating with fewer restrictions on the scope of their investments, and with room to employ hedge fund-like fee structures off limits to mutual fund firms.

Analysts say there were 1,200 private firms focused on A-shares strategies at the end of 2014 — even if only a few handfuls could boast assets under management of more than US$1 billion.

Rachel Wang, a senior analyst based in Shenzhen with Morningstar Investment Management Asia, said recent examples of veteran portfolio managers leaving their fund management companies to join private firms or launch their own firms include:

Chen Yangfan, manager of the renminbi 1.4 billion (US$227 million) AEGON-Industrial Organic Growth Balanced Fund, with a 3-star Morningstar rating, who left Shanghai-based AEGON-Industrial Fund Management Co. last month to set up a private firm;

Deng Xiaofeng, manager of the RMB13.4 billion, 5-star-rated Bosera Theme Industry Stock Fund left Shenzhen-based Bosera Asset Management Co. in December to join GaoYi Capital, the private firm launched by Qiu Guolu earlier that year. Mr. Qiu, in turn, left his post as chief investment officer of Shenzhen-based China Southern Fund Management Co. in March, to start his firm.

Fan Dizhao, manager of the RMB3.99 billion Guotai Jinniu Innovation Growth Equities Fund, which boasts a Morningstar 5-star rating, left Shanghai-based Guotai Asset Management Co. in October to start his own firm; and

Wang Ruyuan, manager of the 5-star rated, RMB7.4 billion Baoying Core Advance Balance Fund and the 4-star rated, RMB4.9 billion Baoying Strategic Growth Stock Fund, left Shenzhen-based Baoying Fund Management Co. in October to set up her own private firm: Hongliu Investment Management.

A critical mass of factors has contributed to the industry's ongoing game of musical chairs.

Chief among them, analysts say, is the prevalence of state-owned companies as owners of fund companies, limiting the scope for offering equity to key employees.

At the same time, regulatory changes — including a move in September allowing back-office and middle-office functions to be outsourced — have made it easier to launch “private” management firms.

That lower barrier to entry has sparked a “bottom-up fight” for better alignment of incentives between key investment teams and their fund management company employers, said Leslie Mao, Shanghai-based director of investment services, China, with investment consultant Towers Watson & Co.

Star managers in China are basically going to their bosses and saying “this is what I want,” he said.

While the one or two recent examples of smaller fund management companies extending equity to key employees haven't evolved into an industry standard, executives realize they have to do something “because they're losing star managers left and right,” said Mr. Salvador.

Alexandre Werno, executive vice general manager of Shanghai-based Fortune SG Fund Management Co., said his firm's solution will be to launch its own “private” affiliate this year —allowing portfolio managers to earn performance fees. (Fortune SG is a joint venture between Shanghai Baosteel Group Corp. and Paris-based Societe Generale.)

The challenge to the industry's organizational stability is flaring up just as many institutional investors — a group that prizes stability when selecting managers — could be taking their first serious look at China's domestic market.

MSCI Inc., the New York-based benchmark index giant, will decide in June whether to include a sliver of China's A-shares market in its emerging markets benchmark beginning in 2016. That move would “increase interest (among) international asset owners” in gaining exposure to the market, noted Mercer's Ms. Tan.

Whether that decision comes this year, “within the next five to 10 years, A shares are going to be in every portfolio,” predicted Theodore Niggli, Shanghai-based managing director of MSCI's index business in China.

And as global managers move to enhance their A-shares capabilities, local firms will face “stronger competition for talent,” said Mercer's Ms. Tan.

Still, some market veterans contend the pursuit of organizational stability has to be part of a broader shift from a momentum-driven market dominated by retail investors to one where institutional investors have greater sway.

“There needs to be a realignment of compensation,” but the key is making sure portfolio managers and analysts are getting paid “for the right reasons,” rather than just throwing more money at them, said Hypatia Kingsley, Shanghai-based managing director, Greater China, with executive recruiter Spencer Stuart.

The goal is to reward people “willing to see past the next two or three years” — looking toward a day when a track record will be increasingly important, Ms. Kingsley said. In that regard, professionals jumping now to start private firms “need to be aware” of the longer-term risks they're taking, she added.

By way of example, Shanghai-based Franklin Templeton Sealand Fund Management Co. isn't looking for portfolio managers who can post the “best” performance over one or two quarters, but the managers who can deliver performance over market cycles, said Xu Lirong, the joint venture firm's chief investment Templeton Sealand Fund Management Co. isn't looking for portfolio managers who can post the “best” performance over one or two quarters, but the managers who can deliver performance over market cycles, said Xu Lirong, the joint venture firm's chief investment officer.

Franklin Templeton Sealand's average portfolio manager has seven years of experience, well above the industry average, because the firm's managers know they won't be sacked if — by sticking to their convictions — they underperform for a year or so, noteTempleton Sealand's average portfolio manager has seven years of experience, well above the industry average, because the firm's managers know they won't be sacked if — by sticking to their convictions — they underperform for a year or so, noted Mr. Xu.

Still, even if the number of private firms with US$5 billion or more can be counted on one hand, some observers predict better alignment of interests will allow the growth of those firms to continue to outpace that of China’s fund management companies.

In a Jan. 4 telephone interview, Max Gottschalk, Hong Kong-based CEO of alternatives manager Gottex Asia, said a focus on alignment of interests drove his firm’s November 2013 decision to partner with VStone Asset Management, a Shanghai-based private asset management firm with US$800 million in AUM.

VStone was launched in 2009 by Chen Ji Wu, a former chief investment officer for both insurance giant China Life and fund management company Fullgoal Fund Management. In 2013, Gottex and VStone formed a joint venture, Gottex VStone, with Gottex holding a significant minority stake, said Mr. Gottschalk, who declined to go into detail.

Gottex officials talked with a number of potential partners but felt most comfortable dealing with private companies, where a stronger alignment of interests ensures everyone is working together and it’s possible to deal directly with a company’s principals — as opposed to firms owned by a state-owned enterprises, where high level turnover is more the norm, he said.

At the time of the interview, Mr. Gottschalk said he and Mr. Chen were meeting in London with institutional investors, who — he reported — appear hungry to learn more about opportunities in China.