This is an excerpt from a story that originally appeared in the July edition of AsianInvestor magazine. To learn more about the content in the magazine, please contact Stephen Tang at [email protected] or on +852 2122 5239.

Thailand has the largest mutual fund market in Southeast Asia and all indications point to that position being secure for at least another five years. While Thailand leads the region in terms of assets, it lags every other market in terms of profit margins, however, and that too is expected to persist.

The reasons Thailand has a large pool of mutual fund assets and it has the lowest profit margin in the region are one and the same: a massive demand for fixed-income instruments that is showing no signs of letting up.

According to Boston-based financial services consulting firm Cerulli Associates, Thailand had $38.5 billion in mutual fund assets as of end-2008; that's 47% of the $82.5 billion in total mutual fund assets in Southeast Asia in the same period. Coming in a far second is Malaysia with $17.8 billion at end-2008.

Cerulli expects Thailand to continue to hold the biggest share of mutual fund assets in Southeast Asia, with projected assets under management of $61.2 billion in 2013. This lead is due to the increasing number of people converting portions of their bank deposits into investments, particularly in fixed-income assets. Corporations also have a growing desire to issue and own bonds.

But in terms of compound annual growth, Malaysia, with a lower AUM base, should have faster growth (CAGR of 12.8% over five years, versus 9.7% projected for Thailand; which is still pretty good).

Fund houses are expanding their product range to include property funds, exchange-traded funds and even hedge funds, but bonds seem to enjoy the most demand. This is not surprising, given most growth comes from flows out of the Bt6.7 trillion ($197 billion) of estimated bank deposits, and partly explains why 80% of Thai mutual-fund assets are already in fixed income.

Another reason: psychology. Demand for the perceived safety of bonds dates to the 1997 Asian financial crisis (which kicked off with the devaluation of the baht), a habit that has only been reinforced by the latest, global crisis, not to mention the political upheavals that have disrupted Thailand for the past two years.

It is useful to remember that before mid-1997, most Thai investors preferred equities. But the Stock Exchange of Thailand Index peaked at 1,789 in 1994; today the index trades around a third of that level.

"A lot of investors got burned [during the 1997 crisis] and never recovered from that experience," says Sukkawat Prasurtying, Bangkok-based CIO and acting CEO of Manulife Asset Management Thailand, one of the six international fund houses operating in the market.

Bank depositors, the main source of fund industry growth, see bonds as a proxy for their deposits. They also like the tax incentives for two structures of mutual funds designed to help invest for retirement: the long-term fund (LTF) and the retirement mutual fund (RMF). Bank deposits are subject to a 15% income tax, but these particular fund products are exempt for the first Bt 500,000 ($15,000) invested in LTFs and RMFs, as well as in Treasury bill products that are dressed up as funds.

Banks are key

Given demand for fixed-income products is very strong, fund players compete by lowering fees. Management fees for fixed income funds in Thailand are extremely low, typically within a range of 0.2% to 0.6% (compared with 1% to 1.7% for equity funds) and there are no front-end or back-end fees. On top of that, fund houses tend to offer volume discounts to select clients depending on how much assets they are managing for them.

This low fee environment makes Thailand a difficult market to operate in, especially for fund houses with no built-in distribution networks. There are 22 asset management companies in Thailand, including the six international fund houses.

Bank distribution remains the key ingredient for success in the mutual fund industry in Thailand. With networks of around 500 to 600 branches nationwide, banks provide a powerful built-in distribution network for their asset management units. Siam Commercial Bank Asset Management, a unit of Siam Commercial Bank; Kasikorn Asset Management, a unit of Kasikorn Bank Group; and BBL Asset Management, a unit of Bangkok Bank, continue to corner a substantial share of the market. Their combined AUM is 50% of the total mutual fund assets in Thailand.

Find your niche

Fund houses with no bank affiliations don't compete head-on with the major players in the market. Instead, they focus on their respective niches. ING Funds has a strong provident fund business; Aberdeen Asset Management Thailand is building on its strengths in equity portfolio management and is targeting the minority of investors who go for equity products; Manulife Asset Management Thailand is focusing on attracting high-net-worth and institutional investors.

"We believe there will be a gradual shift to equities just because the level of sophistication is growing in Thailand," says Ai Meun Lim, a Singapore-based director at Cerulli. "Plus, foreign fund managers are still very much focused on their equity funds."

Aberdeen offers 15 mutual funds in Thailand, of which 12 are equity portfolios. Included in the 15 funds are four equity-focused foreign investment funds, which invest in Asia-Pacific ex-Japan, global, European, and emerging market equities.

"We are a niche player in Thailand. We are focusing on competing in some segments of the market, particularly equity, which is our strength locally and in the region," says

Chaikaseam Vadhanasiripong, head of funds distribution at Aberdeen Asset Management Thailand.

Three maybes

There are other opportunities that industry players expect will boost the mutual fund industry in Thailand, but these are likely to come several years down the road.

These include the gradual removal of the blanket guarantee on baht-denominated bank deposits starting August 2011, the eventual creation of a national pension scheme, and the efforts to build a market for sharia funds.

The Deposit Insurance Institute Act was supposed to take effect in August 2008, but was put on hold due to the global financial crisis. The act will reduce the guarantee on bank deposits to Bt100 million ($2.9 million) during the first year of implementation and then to Bt1 million ($29,000) beyond that. This is expected to lead to more money shifting from bank deposits to mutual funds. The existing blanket guarantee was put in place after the Asian financial crisis in 1997, which was triggered by the collapse of the Thai baht.

Meanwhile, if things proceed as intended, Thailand is expected to establish a National Pension Fund (NPF) within the next two years, in order to build a safety net for workers currently outside of existing state pension programmes, such as the Government Pension Fund (GPF). Industry players are not holding their breath, however, because efforts to create a national pension scheme have had many false starts over the years.

Thirdly, Thailand is the latest to join the campaign to attract the growing pool of global money looking for sharia-compliant investments.

In May, FTSE Group and the Stock Exchange of Thailand expanded the FTSE SET Index Series with the addition of the FTSE SET Shariah Index. Using the FTSE SET All-Share Index as the base universe, the index is screened by Yasaar Limited, a leading sharia consultancy. Unlike other methodologies, the FTSE SET Shariah Index uses asset-based debt screening, the same that is used for the FTSE Shariah Global Equity Index Series. This is a more conservative approach to sharia compliance. The resulting methodology is less speculative and more in keeping with sharia principles ensuring companies do not qualify for the index simply due to market cap fluctuations.

"This new index will serve both domestic and international investors looking to invest in a transparent and sharia-compliant manner, as well as help issuers create structured investment products tailored to the global Islamic market," says SET president Patareeya Benjapolchai.

Industry players don't expect the sharia market in Thailand to achieve anywhere near what Malaysia has achieved, however, because of the significantly smaller Islamic population in Thailand and the absence of incentives that are present in Malaysia such as the Islamic fund management licenses being granted to foreign fund houses wishing to set up shop in that market plus, tax incentives, plus the seed money from the Employees Provident Fund.

While the landscape of the asset management industry in the Unites States, Europe, and some parts of Asia is evolving, the same cannot be said for Thailand. Even the attempts of local banks to build stronger wealth management and private banking businesses are meeting a lot of resistance from their asset management company affiliates. So for a few more years, fund houses -- both local and international -- that do not have the backing of a bank distribution network will have continue to create pockets of opportunities for themselves whether it be in the type of products they offer or types of clients they attract.