Big hedge funds get cold shoulder in China

Three years after China opened its 2.5 trillion yuan ($355 billion) hedge fund market to global asset managers, the industry is discovering just how hard it is to win over the country's investors.

BlackRock Inc., Man Group and 20 other foreign firms licensed to run Chinese hedge funds — or private securities funds, as they're known locally — amassed about 5.8 billion yuan of assets as a group as of August, according to data compiled by Shenzhen PaiPaiWang Investment & Management Co. The meager haul — amounting to 0.2% of hedge fund assets in China — reflects a host of challenges.

International names like BlackRock don't resonate much in China's crowded market of close to 9,000 hedge funds, which has its own set of local stars. The world's largest money manager is routinely confused with private equity giant Blackstone Group Inc. UBS Group's shared Swiss roots with Credit Suisse Group mean their Chinese abbreviations are just one similar-meaning character apart, also prompting mix-ups.

The limited name recognition is compounded by distribution hurdles. It all suggests a long wait before China turns into a meaningful source of profit for international money managers, which are desperate for new avenues of growth as clients in developed markets shift toward low-fee investments.

"Building a brand in China is definitely a challenge for some foreign players," said Hersh Gandhi, Man Group's managing director for Asia-Pacific ex-Japan. "We've been thoughtful about the strategies we want to run and the market segments we want to be in, and have sized our operations accordingly."

Man Group declined to comment on its assets and profitability in China. It, UBS and BlackRock oversee 100 million yuan to 1 billion yuan each, according to ranges from PaiPaiWang, which tracks hedge funds in the country.

Winton Group has the biggest share of onshore money — roughly 2.5 billion yuan — after spending several years building an advisory business in China before receiving its private fund management approval in 2018.

Excluding Winton puts the average for the rest at about 170 million yuan, 36% below the local mean, according to data from the Asset Management Association of China and Bloomberg calculations. Nine manage less than 100 million yuan, including Fullerton Fund Management Co. and Invesco, which both won licenses more than two years ago. Three that have yet to launch a product or did so only recently aren't included in the calculation.

Invesco declined to comment on investment flows, saying in an e-mailed statement that the company is "committed" to its mainland China business. Fullerton didn't immediately reply to a request for comment.

Fundraising difficulties are common, according to Yan Hong, director of the China Hedge Fund Research Center at the Shanghai Advanced Institute of Finance.

Foreign managers probably can't make much money managing less than 1 billion yuan, given the operational and compliance costs, he said. But big global players with deep pockets may view such initial difficulties as manageable while they wait for longer-term opportunities.

The task of building a presence was complicated by a rule change last year that blocked easy access to retail investors through securities firms and banks, forcing funds to go down a more costly path of chasing qualified individual investors.

Another stumbling block is the extreme bets some local managers are willing to make to produce the stunning returns known to draw Chinese investors.

China's five-year champion among private stock funds — Shanghai Panyao Asset Management Ltd. — boasts a 515% cumulative return (the No. 2 fund is up 494%), according to PaiPaiWang. The top 10 performers among the largest local players had an average return of 37% in the first 10 months of 2019.

While comparable data for foreign funds isn't available, BlackRock's first product returned about 10.3% as of Nov. 15 since its inception in May 2018, a person familiar with the matter said, asking not to be identified because the fund can't be promoted to investors other than institutions or qualified clients. That compares with an 8.6% decline in the Shanghai Composite index during the period.

The company didn't respond to a request for comment on its assets under management in China or its products' returns.

Wang Linggang, who was BlackRock's China compliance officer from 2017 until earlier this year, said foreign funds "have to accept" the local common practice of ceding part of management fees to distribution channels to ensure sales. They also need to follow the stricter anti-money laundering and anti-terrorism requirements of their home jurisdictions, where tougher criteria may cost them clients, he wrote in an Aug. 13 article on the Wechat account of consultancy Financial Regulation & Law.

The reputation global managers have for being more stable and disciplined is starting to attract high-net-worth clients, particularly those wary of irregularities and performance volatility among local funds.

UBS, which entered China in the 1990s and is among the largest foreign players in this sector, introduced its fifth product in July — a fund of hedge funds, where investors can put money into products managed by both local and foreign hedge funds in China.

The private funds unit has tapped into UBS' existing distribution channels and leverages its wealth management clients, according to Adrian Chen, general manager of UBS Asset Management (Shanghai) Ltd. "The client base available now in China already presents us with a big market," he said.

Kevin Wu, who works in Shanghai's financial services industry, plowed 1 million yuan into a BlackRock product in August 2018, diversifying his portfolio to try out a global player with a relatively low fee.

The investment has so far yielded about 15% after fees, beating local stock indexes but trailing returns of some of Wu's own share holdings in companies like Ping An Insurance (Group) Co. and Jiangsu Hengrui Medicine Co., both of which jumped at least 40% over the period.

"It depends on your expectations," Mr. Wu said by phone. "As long as they can yield around 12% a year, I can totally accept that."

High returns remain a draw among most though, prompting a constant churn and defeating regulatory efforts to encourage longer-term horizons. China's hedge fund investors hold for an average of six months compared with around four years globally, estimates from PaiPaiWang and Preqin Ltd. show.

The "velocity of money in and out" is high even by retail standards, said Man Group's Mr. Gandhi. "Foreign players need to accept this as part of the local landscape."

The foreign options available are also expanding as more funds are drawn in by the roughly 60 trillion yuan of investable assets China's high-net-worth individuals hold. Many are also looking ahead as the Asian nation looks to unshackle its 14 trillion yuan mutual funds industry.

Five overseas companies have made inquiries with Fangda Partners about hiring the law firm to apply for a private securities fund management license, according to partner Ren Zhiyi, who has represented Bridgewater Associates LP in China. LLinks Law Offices, which advised BlackRock, has about the same number of clients making preparations, partner Sandra Lv said.

"This is a huge market with a lot of potential," said Natasha Xie, a Shanghai-based partner with JunHe LLP, who says the number of registered foreign hedge funds may reach about 30 by the end of 2020.

All three law firms declined to identify individual clients.

Eastspring Investments, Prudential's asset management arm, registered as a private fund last year and is focusing on establishing a track record with its first product launched in April, said Bernard Teo, the head of corporate strategy. It took more than six months of interviewing for the firm to hire a local fund manager with the right mix of performance and risk controls, he said.

Mr. Teo may need to brave the industry's talent crunch again as he weighs adding local multiasset and quantitative teams. "You certainly need to have the patience for the long term," he said.