A-share volatility set to boost foreign managers' business

China's wild market ride could benefit foreign managers using mutual recognition as domestic retail investors look for global allocation, according to a market-watcher.
A-share volatility set to boost foreign managers' business

China’s stock market crash could have a silver lining for foreign managers benefiting from increased demand for overseas exposure, a consultancy has predicted.

Hong Kong-China mutual recognition is expected to increase demand for foreign exposure with the scheme providing cautious Chinese investors with an additional investment channel beyond A shares.

While much of the attention has been focused on Greater China funds in mutual recognition, international players are readying international products for domestic retail investors.

With China’s equity market finally stabilising after a series of government interventions over the past two weeks, asset managers have adopted a cautious attitude towards the highly-volatile emerging market. The CSI 300 index has rebounded 12.4% over the past four trading days, following a fall of 26.6% after its closing peak of 5,371 points on June 10.

The market volatility is set to impact foreign and domestic managers’ business in mainland China in different ways, according to Shanghai-based consultancy Z-Ben Advisors. Foreign managers could benefit from domestic retail investors’ changing attitude to overseas exposure, particularly through fund sales under mutual recognition, while domestic fund managers will be looking to add to their product shelves in order to withstand volatility.

“Although initial [northbound] mutual recognition participants are walking into an industry with less-than-ideal fundraising conditions, changing investors’ tastes could encourage AUM retention,” noted Z-Ben. “Mutual recognition managers may prove more immune to the huge outflows seen among some domestic peers in time of volatility.”

Z-Ben said Chinese retail investors will inevitably change their behaviour by adding overseas allocations. Currently more than 95% of their investments are focused on mainland China, an allocation profile which has become tarnished by recent market turbulence. However, global diversification is still in its infancy among most retail investors.

“This change in attitude is extremely well-timed as mutual recognition debuts,” noted Z-Ben.

The consultancy’s research manager Ivan Shi said that first-movers in mutual recognition stood to reap the benefits of this change.

“Some investors may start to look into global diversification now, given the huge market volatility, and such conditions should benefit some first-round managers in mutual recognition if they approach this properly,” Shi said. He stressed that market volatility may not be over yet, and investors’ attitudes would not change overnight.

Mutual recognition was launched on July 1, and six northbound foreign managers submitted applications for a total of 11 funds in the first three days. Market participants expect the first funds to be approved by the China Securities Regulatory Commission (CSRC) by the end of July.

Although the first wave of product launches are likely to be dominated by Greater China equity funds, some managers have focused on retail investors’ global market needs. For example, Schroders has submitted an application for a multi-asset product investing in Asia, to satisfy domestic investors’ need for diversification and global exposure.

Market volatility usually brings turbulence to domestic asset managers’ AUM as most of them rely heavily on equity market rallies to push up asset prices and facilitate the launch of new funds. Z-Ben pointed out that small and mid-tier firms, such as Invesco Great Wall and Morgan Stanley Huaxin, have been worst affected by the market storm, because significant daily NAV adjustments in excess of 10% have pointed to redemptions, according to Z-Ben data. Since China has a 10% cap on daily share price changes, a fall in a fund’s NAV of more than 10% fall suggests redemptions from investors. 

It is not just asset price falls and redemptions which have caused a drop in fund companies’ AUM. Z-Ben noted that IPO fundraising has cooled down quickly, with the highs seen in the first half having now fallen to the lows of last November. The number of fund applications in the pipeline is no longer in the 100s and is only just above 50.

Shi said the biggest risk for mutual fund operations, from a corporate management point of view, was AUM volatility caused by investors’ subscriptions and redemptions. He said that this has had a destabilising effect at the senior executive level in the past.

“The best way for fund companies to deal with this kind of situation is to have a well-balanced product portfolio, such as what top-tier firms like ICBC Credit Suisse or Harvest have,” Shi said. “Mutual fund business is not only about AUM growth when the market is good; it's also about retaining AUM when the market turns weak.”

An ideal product shelf for a Chinese fund company should include a strong money market fund, paired with a broad range of balanced fund structures, and peppered with eye-catching thematic offerings, Z-Ben noted.

China’s fund industry assets hit a new record of Rmb7.4 trillion ($1.2 trillion) at the end of May, when the equity market rally was close to its peak. The size of the market had fallen by just 1.4% to Rmb7.1 trillion by the end of June, according to the latest data from the Asset Management Association of China. July figures have not yet been announced.

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