It's too early to call China's qualified domestic institutional investor (QDII) programme a success or a failure. But it is not entirely without merit, say leading players in fund management, legal and custody attending AsianInvestor's second institutional investment conference, which drew a crowd of 240 from the institutional and fund management world in Beijing last week.
New opportunities are opening up in the QDII market, and more focused funds will help the market to diversify, but product launches may be delayed due to interest being diverted to the launch of the local Growth Enterprise Bourse, according to QDII market participants.
According to statistics from the State Administration of Foreign Exchange (Safe), the scale of the programme has been extended to a total of $60 billion in terms of foreign exchange quotas. In particular, QDII funds have managed to raise up to $12 billion.
Among the existing nine QDII funds, the huge variance in fund performance is alarming. Jeff Schoenfeld, a partner and co-head of institutional fixed-income management at Brown Brothers Harriman, says the variance has mostly been driven by the timing of the launches, and further widened by the currency management strategies adopted by fund managers.
Only two funds were launched in the teeth of the bear market, and they were the only ones of the nine that managed to gain positive returns since their launch. Yet timing fund launches aside, Schoenfeld says fund managers often neglect the potential returns they could gain from hedging the renminbi.
Strangely, most fund managers still do not take a view on the appreciation of the renminbi. As one of the leading overseas custodians partnering with ICBC on QDII fund services, Schoenfeld observes that judging FX rates right has meant a 10-20% difference in fund returns.
While most QDII funds are marketed as active global strategy products, in reality most of the first-generation QDII funds were positioned to gain upside from Hong Kong-listed H-shares and red-chips. This is set to change, says Hubert Tse, head of international business at Yuantai PRC Lawyers. (His house has advised four QDII fund players, leading some of the more notable launches by Southern, ICBC Credit Suisse, Yinhua and Bocom Schroders.)
Tse reveals his firm is working on getting another batch of such funds approved. He says there are some 10 to 15 products Yuantai is working on that have already been approved by the China Securities Regulatory Commission (CSRC), and are only awaiting a further forex quota from Safe. Yuantai is advising another five out of 12 funds awaiting CSRC product approval.
In the forthcoming batch of funds, product strategies will further diversify from the current dominance by H-share-themed equity products to include more fund-of-fund, balanced-portfolio and even fixed-income strategies.
Tse speculates with the continued strong sentiment for A-share stocks and launch of the Growth Enterprise Bourse this year, fund houses will most likely work on related products and divert attention away from the still-weak demand for overseas products, making a launch for QDII mutual funds this year less likely.
Tse says that since his clients Southern and ICBC Credit Suisse's split with their original foreign investment advisers, more Chinese fund houses will internalise their resources to come up with their own QDII offerings. However, for small- and medium-sized houses without the capability and expertise to build on such teams, the desire to work with foreign advisers remains strong.
More such advisory opportunities may open up for global houses following the CSRC's Qingdao meeting earlier this year. The CSRC has been encouraging both domestic and, in particular, foreign joint ventures to shop around for the best capabilities before opting for a foreign shareholder as adviser by default, says Tse.
Zhang Houyi, deputy general manager at China Asset Management, says the QDII industry will need to upgrade its investment and research capabilities. For one thing, the CSRC has created new opportunities for fund houses by making QDII segregated accounts available to investors. This new area of business looks set to further differentiate the competition.
For QDII mutual funds, meanwhile, Zhang says the industry will see more focused products appearing in the market. US equities, single-country products and sector funds in tech stocks or medical themes will soon surface, while more fund investors will tilt towards passive offerings.
As Chinese investors mature, the market appetite for value-based investments is set to deepen. Even though the QDII programme has been around in China for three years, the makings of a fully functioning QDII market has only just begun and Chinese banks are poised for this unique expansion through partnerships with overseas custodians.
Cui Yan, director for the overseas custody business at ICBC, says China's development pattern is likely to mirror that of Taiwan. There, demand for offshore products was slow for the first decade or so, then it shot up from 2003 onwards, she says. Offshore investments from Taiwan more than doubled from $20 billion to $50 billion between 2003 and 2006.
Yet as more of these products become available, Chinese banks are tasked with the dilemma of handling hedging, cash and liquidity management, issues that the industry has never dealt with. Dealings with more complex passive products may become particularly challenging, making partnerships with sophisticated overseas players ever more important, as Chinese custodians draw on their experience.