China opens up interbank bond market to hedge funds

Private securities fund firms have been given access to China's interbank bond market, but they face asset flight risk from investors determined to chase high equity returns.
China opens up interbank bond market to hedge funds

Private securities fund companies have been given the green light to enter China’s interbank bond (IBB) market.

The liberalisation comes as part of government attempts to reform the bond market by diversifying the pool of eligible investors.

However, private managers’ limited knowledge of fixed income and the difficulties they face in holding onto investors hungry for high returns could make for a slow entry into the market.

Eligible private securities fund managers – China’s equivalent of hedge funds – who own assets worth more than Rmb10 million ($1.6 million) will be qualified to apply for an IBB licence, the People’s Bank of China announced last week. The central bank released a document detailing the move on June 16 but did not state when the change would come into effect.

Previously, private fund managers were not allowed to participate in the IBB market directly, with many of them having to use alternative platforms like trust companies or mutual fund companies’ segregated mandate accounts.

Earlier this month, the Shanghai and Shenzhen stock exchanges announced that private fund firms would be able to enter the bond exchange market and trade fixed-income securities.

China‘s bond market is still under-developed as mutual and private fund managers’ participation remains limited. Only Rmb372 billion of assets come from pure bond funds, representing 5% of the domestic mutual fund industry. However money market funds, which manage Rmb2.5 trillion, also invest in the bond market.

Private bond fund managers have assets worth about Rmb100 billion, according to Shanghai-based consultancy Z-Ben Advisors. The figure represents 8.7% of the total assets held by private fund managers as of the end of May.

Alexis He, a Z-Ben analyst, said part of the reason private managers do not focus on the bond market is because the pool of fixed-income instruments on the exchange market is limited, particularly on the Shenzhen bourse.

“[Private] managers are not well-versed in fixed income strategies and investors cannot switch their mindset from chasing equity returns,” He said. He added that some industry leaders have sophisticated strategies, including algo-trading and quantitative strategies, which compare favourably to global standards.

Yet He said that even if some managers tried to employ sophisticated fixed income strategies, they would see investors withdraw assets because of their desire for high returns. He added that small private managers found it difficult to execute such strategies because of investors’ demand for returns. 

There were 72 private managers and a total of 382 products focused on fixed income strategy in China as of the end of 2014, with many of them owning assets worth more than Rmb3 billion due to leveraged strategies, according to Beijing-based distributor Gesafe Wealth Advisory.

Presently, Beijing Lerui Asset Management and Beijing-based Pengyang Investment are the largest bond fund managers in China’s private segment, with each of them managing assets worth more than Rmb13 billion, He noted.

Investors in the industry’s leading bond managers are mostly institutional clients such as banks and corporate treasury departments; but most small-sized players’ clients are individual investors who usually chase high returns.

China’s bond market is the third-largest in the world and was worth Rmb29.6 at the end of May, with 93% of assets in the IBB market, according to the China Central Depository & Clearing Company.

Earlier in May, China added to its liberalisation drive by allowing more foreign investors to enter the IBB market, as reported.

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